Technology stocks are leading the market to new highs. Over the past year, the tech-heavy Nasdaq Composite has gained 25%, while the broader S&P 500 Index has returned 14% in the same period.
With the major indexes reaching record levels, value is hard to find. The good news is that it’s still possible to find cheap stocks, even in the tech sector.
Cisco Systems (NASDAQ: CSCO) is arguably the cheapest mega-cap tech stock. Not only is Cisco’s core business being undervalued for its potential growth prospects, but it is even more undervalued when its massive cash hoard is taken into account.
Here’s why Cisco stock is an attractive buy for value and income.
Growth In New Technologies
The biggest reason that Cisco stock remains undervalued is because investors have grown pessimistic about the state of its routing and switching businesses. These businesses propelled Cisco to become the industry giant that it is today. However, these two businesses are slowing down, due to market saturation.
Combined, routing and switching make up more than half of Cisco’s total revenue. But routing and switching revenue declined 4% and 2% over the first three quarters of its current fiscal year. This will make it hard for Cisco to grow, given the size of these two businesses.
As a result, Cisco needs to adapt, and expand into new areas. Fortunately, it is — by investing organically, and through acquisitions. Cisco is making huge investments in new technologies, which is already paying off. For example, Cisco’s wireless and security businesses grew revenue by 5% and 12%, respectively, over the first three quarters of the fiscal year.
Not only that, but Cisco is also building up its Internet of Things business. IoT is an emerging technology that promises to connect a range of devices, including household appliances, automobiles and more. No longer will smartphones and tablets be the only devices with connectivity. The potential is striking: technology market researcher Gartner (NYSE: IT) estimates that connected devices will increase by fourfold to 20 billion by 2020.
To gain entry into the IoT, Cisco is making several bolt-on acquisitions. Earlier this year, acquired software maker AppDynamics, for $3.6 billion. AppDynamics’ software is used in the financial services and retail industries, to boost companies’ corporate networks. Later, Cisco acquired device connectivity software maker Jasper Technologies, for $1.4 billion.
On July 13 Cisco announced the pending acquisition of Observable Networks for an undisclosed sum. Observable Networks makes cloud-based network forensics security applications, delivered as a service. This gives Cisco a greater foothold in cloud infrastructure. Like the IoT, the cloud is a massive growth engine for the technology industry.
Cisco’s aggressive acquisition strategy is fueled by its excellent balance sheet.
Cash Hoard Is A Catalyst
Cisco has an iron-clad balance sheet, which allows it to invest in new growth initiatives. As of its most recent fiscal quarter, Cisco held $68 billion in cash and equivalents, and investments. This is a huge stash of cash, which represents more than 40% the company’s market cap.
This jumbo cash hoard makes Cisco deeply undervalued. On a normal P/E basis, Cisco stock trades for 15 times earnings. This is already a cheap multiple, given the company’s long-term growth potential. But Cisco has nearly $14 per share in cash. Excluding cash, Cisco stock trades for a P/E of just 8.
When including cash on hand, Cisco stock trades at a massive discount to the broader market. The S&P 500 Index has an average P/E ratio of 25. Not only that, but Cisco has a nearly 4% dividend yield. As a result, Cisco stock could generate total annualized returns in the mid-to-high teens moving forward, comprised of earnings growth, dividends, and expansion of the P/E multiple.
Cisco Stock is a Bargain
Cisco stock has significantly underperformed the market over the past year. Investors appear to have grown frustrated with the company, as Cisco expects flat revenue for fiscal 2017. However, investors would be wise to be patient.
While Cisco’s investments are not likely to result in growth this year, they lay the groundwork for future growth. The IoT, security, and the cloud are all poised to be huge growth industries moving forward, and Cisco’s aggressive investments now will likely pay off big later.
In the meantime, investors are buying a very cheap stock, with a high dividend yield.