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Friday, August 13, 2010

Cisco Systems: Everyone's an Economist in a World Awash with Lemmings (Many Already in the Water!)

We've backlog of topics to share, but will again briefly relay how everyone is an economist. We wrote about this in May 2009 and have included various related tidbits in other posts, including our "how's the economy doing?" series. Essentially, in our interconnected world -- where information travels the speed of light -- everyone from large organizations and Wall Street, to government leaders and lone individuals on Main Street seemingly tends to fixate on the latest news, whether positive or negative. That is, lemming behavior is amplified on many levels, not just in the "Market."

Here, we use Cisco Systems (CSCO) as an example, which missed earnings expectations and tempered its tone on the technology market versus the prior quarter. The markets pulled back yesterday and the WSJ published the following headline story last night
  • Dow's Losing Streak: 3 Days: Stocks declined for a third straight session as economic warnings from weekly jobs data and Cisco Systems added to investors' concerns about a possible double-dip recession.
Wall Street sell-side analysts didn't react kindly -- from TheStreet.com:
  • Cisco Systems (CSCO:NYSE) downgraded at BMO from Outperform to Market Perform. $23 price target. Estimates also cut, as business momentum has stalled.
  • Cisco Systems (CSCO:NYSE) estimates lowered at Morgan Stanley through 2012. Company is seeing lower gross margins, but spending more and facing a higher tax rate. Equal-weight rating.
  • Cisco Systems (CSCO:NYSE) downgraded at Oppenheimer from Outperform to Perform. Company reported a mixed quarter and has a soft outlook.
Clearly, expectations matter and, in a myopic-please-me-now Market, this is especially true. No matter than Cisco was trading at 12 times forward earnings with approximately one third of the company's market capitalization represented by net cash on the balance sheet. Or, forget the 20% plus operating margins and high teens return on equity (ROE). The Market wants a beat and raise quarter like that delivered by Priceline.com (PCLN) and our microcap holding Sonic Foundry (SOFO) last week. Recent performance for shares of these companies versus the Nasdaq index from Google Finance:

Back to Cisco: we recommend reviewing the company's results, Webcast, and earnings presentation. We don't have time to share all of the details or key slides, but a quick perusal reveals impressive growth:

The other slides around geographic and product performance are worth a look. Even "U.S. and Canada orders were up approximately 20% Y/Y.

BUT, here are the slides/commentary that caused most consternation:


The Market fixated on the "unusual uncertainty" comment and guidance that was just slightly lower than expectations - from management commentary: "For Q1 FY11 we anticipate total revenue to be up approximately 18-20% year-over-year."

We could discuss a few more things, including Cisco's focus secular growth areas such as video (read: related to our Sonic Foundry thesis), but need to wrap this up for now. CNBC featured CEO John Chambers yesterday morning, giving him an opportunity to put on his helmet and body armor, and defend his Thursday commentary. Give a look and you be the judge - how bad are things, really?

Note some of his commentary:
  • "awesome quarter"
  • "in terms of economy, we share what we're hearing from our customers"
  • "seeing very gradual recovery"
  • "customers hesitant about hiring, new jobs, and capital spending [but still expecting growth, maybe somewhat lower than pace anticipated several months ago]"
  • "added 2,000 new employees last quarter, 70% in U.S."
  • "adding several thousand employees over next several quarters"
  • "feel very good about our future"
  • "think stock will take care of itself if we do those [growth numbers]"
  • "optimistic about future of U.S., I think we're on beginning of decade long productivity run"
It should come as NO SURPRISE to anyone that growth is decelerating from robust, EASY, Y/Y comparisons during the first half of 2010 versus a very weak first half in 2009. Of course, the wall of worry is difficult to overcome and a sensational media is quick to latch onto the idea that a "double dip" is just around the corner. We know jobs figures have been disappointing, too, even if new claims for unemployment are declining faster than in 2002 and 1992. The risk remains that real economic behavior is being impacted by pervasive negative psychology, leading to tightening corporate and consumer purse strings around the globe. Again, lemming-like behavior amplified by easy, rapid information flow. Follow the leader, follow the leader, but who's the leader and where is he/she going?

Yet, per our prior posts, growth is better than no growth and most companies are seeing stable to better results. Some, like Priceline.com, Sonic Foundry, and even Macy's are beating expectations. Plus, small industrial companies like WD-40 (WDFC) are also raising guidance and global shipping companies are posting solid results on the recovery in global commerce. We'll come back to this last point in a future post.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SOFO.
© 2010 Jeffrey Walkenhorst
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