When a Dud Becomes a Buy

 | May 17, 2013 | 2:00 PM EDT  | Comments
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If you had invested $10,000 in Cisco Systems (CSCO) at the end of 1990, it would have been worth $3.4 million at the end of 1999. But if you had kept holding the stock, your $3.4 million would have shrunk to $1.6 million now -- even after taking into account Thursday's jump of more than 12%.

Cisco, the great success story of the 1990s, has been a great dud since then.

But I believe now is a good time to buy the computer-networking leader. Analysts expect it to earn $1.85 a share this fiscal year (ending July), up from $1.49 last year. That is a 24% jump, and it comes on the heels of a 27% earnings improvement in fiscal 2012.

The interesting thing is that analysts expect things to get worse from here on in. For fiscal 2014, the consensus foresees profit of only $1.79 a share, down 3% from this year. For 2015, the Wall Street crowd expects $1.95 earnings -- a record to be sure, but only single-digit growth.

Still, stocks advance by exceeding expectations, and low expectations are easier to exceed than high ones. As a result, there is room for positive surprises in the next couple of years.

I do not believe that investors have "missed the move," either, despite the 12.6% climb Thursday and the rally in five of the past six trading days. The stock commands less than half the price for which it sold in its glory days, and the valuations today are reasonable. At just under 15x earnings, Cisco trades well below its 10-year average price-to-earnings multiple of about 20x.

Cisco's flagship business, computer networking, is not growing as fast as it had once done. But it has moved into related businesses, including connections for mobile devices, Internet security and other software and services.

Eight of the 10 institutions that hold the most Cisco stock have added to their holdings over the past three months. In addition, the company has bought back a boatload of stock. I am hoping it will authorize further major buybacks.

When Cisco shares hit their peak more than 13 years ago, the company's revenue totaled about $12 billion and profit was at about $2 billion. Today, revenue comes to about $40 billion and its bottom line is well above $7 billion. Meanwhile, the stock price has been cut in half. I have no doubt the shares were overvalued back then -- but I think they may be undervalued now.

John Dorfman is chairman of Thunderstorm Capital LLC, a money management firm in Boston. He can be reached at jdorfman@thunderstormcapital.com.

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