Analysts and investors are devoting a lot attention to companies with hefty and growing amounts of cash on their balance sheets, and applying pressure on them to either put the money to work or to pay out larger dividends. While Apple is clearly the company in the spotlight – with nearly $100 billion in cash, it has yet to initiate a regular dividend — another company that investors could take a hard look at is Cisco Systems (CSCO.O), given that the $46.5 billion in cash and short term investments on its books represents almost 45% of the company’s current market capitalization. The strong StarMine Earnings Quality (EQ) model score of 93 indicates that the Cisco’s earnings seem to be sustainable in the coming quarters. That means that, all else remaining constant, Cisco is only likely to see that mountain of cash grow larger still over the remainder of the year.
StarMine uses computer-driven models to analyze the financial statements calculate a proprietary StarMine Earnings Quality (EQ) scores for each security, with those companies recording the highest StarMine EQ scores being the most likely to be able to sustain their past earnings track record. (For a more detailed explanation of this model, please refer back to this recent look at American Express.) This look at Cisco System’s earnings is the next installment of our series of examining examples of companies across North America that rank either especially high or low by our quantitative earnings quality measure.
One hallmark of companies that report large and growing cash positions on their balance sheet is a combination of strong net income and high cash flow, and Cisco is no exception to that rule. In the latest quarter, the company reported net income of $2.2 billion, the highest it has seen in the last two years, and robust free cash flow (FCF) of $2.8 billion. When earnings are backed by such strong FCF, they tend to be sustainable in the coming quarters. That is captured by the chart below, in which the green bars represent the amount by which FCF exceeded the company’s net income, showing that has been the case at Cisco in the past five quarters.
Source: Thomson ONE / StarMine
Sell-side analysts do have some bones to pick with Cisco, notably the company’s falling margins. As can be seen in the chart below, the operating profit margin for Cisco for the trailing four quarters (represented by the blue line) has declined steadily over the course of the last five years, reaching its lowest point of 19.7% in October 2011. That is still far above the industry median of 7.8%, (represented by the gold line in the chart below) and when the company reported earnings on February 8, 2012, it had grown to 21.5%, the highest level in more than a year. In fact, the margin improvement in the last quarter came in spite of the fact that the rest of the industry is actually seeing margins fall, and can be attributed to cost cutting measures by Cisco during the last year. Despite reining in spending, analysts point out that Cisco actually took market share from competitors (like Juniper Networks) in the service provider space, a part of the market that is growing as demand for routers and switches accelerates. That is a strong sign for future earnings sustainability.
Source: Thomson ONE / StarMine
This previously published article suggests that fund managers are increasingly interested in holding stocks of information technology companies. The StarMine Smart Holdings (SH) model, which gauges the level of buying interest on the part of institutional investors, gives Cisco a very high score of 97. That indicates that Cisco offers investors many of the fundamental characteristics that fund managers have been shown to favor, judging by the companies the latter are adding to their portfolios. In evaluating what is in favor with investors, the Smart Holdings model screens for several kinds of factors, including profitability and earnings quality. With so much cash on its balance sheet, and continued strong earnings on the horizon, it shouldn’t be much of a surprise that Cisco is attracting increased investor attention – nor will it be a surprise if the company continues to increase its dividend payout.
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