Cisco Systems (CSCO: $44/share) – Closing Long Position – up 62% vs. S&P up 32%

Cisco Systems was originally selected as a Long Idea on 11/25/14. At the time of the initial report, the stock received an Attractive rating. Our investment thesis highlighted a high return on invested capital (ROIC), significant growth opportunity from the Internet of Things (IoT), and an undervalued stock price.

During the 1,416-day holding period, CSCO outperformed as a long position, gaining 62% compared to a 32% gain for the S&P 500.

CSCO was downgraded to Neutral on 9/26/18 after the rising stock price made the valuation more expensive.

The company continues to be highly profitable, and its $46 billion in excess cash gives it plenty of resources to acquire innovative startups to make up for the difficulties in innovating that any giant company will have. However, the company’s ROIC declined from a peak of 18% in 2016 to 15% in 2018, which, combined with the rising stock price, makes the valuation less appealing. At its current price of $44/share, CSCO has a price to economic book value (PEBV) ratio of 1.3 and a market implied growth appreciation period (GAP) of 11 years.

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Even though we still like the long-term outlook for CSCO’s business, the stock no longer presents the quality risk/reward it once did. We are closing this position and waiting for a potential pullback or fundamental improvement to get back in.

Figure 1: CSCO vs. S&P 500 – Price Return

Sources: New Constructs, LLC and company filings

Note: Gain/Decline performance analysis excludes transaction costs and dividends.

This article originally published on October 15, 2018.

Disclosure: David Trainer, Kyle Guske II, and Sam McBride receive no compensation to write about any specific stock, style, or theme.

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