It’s a question investors ask themselves every day. Do I accept the higher risk linked to the bigger potential reward from buying a single stock, or do I seek safety in numbers (and potentially more moderate returns) by buying into an index?
The answer (as always) is: It depends. The market’s condition, the economic backdrop, a particular company’s prospects, and that stock’s current price are all factors that contribute to the right answer.
To this end, if you’re currently comparing networking giant Cisco Systems (NASDAQ: CSCO) to a fund mirroring a broad index like the Nasdaq Composite (NASDAQINDEX: ^IXIC), Cisco is the hands-down winner.
Cisco’s fall out of favor makes it favorable
This wasn’t necessarily the case a few months ago, mind you. And it may not be the case a few months from now. It is the case right now, however, for a couple of reasons.
Chief among these reasons is that Cisco share prices are down more than 8% since their late-August peak, although they don’t entirely deserve to be.
The sell-off is superficially understandable. The company has sidestepped the worst effects of the worldwide semiconductor chip shortage, but it’s not completely immune to it. The company’s lackluster guidance for the quarter now underway didn’t help matters, although the 66% run-up from last October’s low to August’s high left the stock unfairly vulnerable to profit-taking. A downgrade by Morgan Stanley analysts a little less than a month ago only ended up fanning the bearish flames.
The selling, however, largely looks past the evolution that Cisco is undergoing.
One big change is the company’s foray beyond hardware production, like switches and routers, into software that helps manage networks. Services is also a key profit center for the company that wasn’t a focus before. Of its recently ended fiscal 2021, nearly 17% of Cisco’s $49.8 billion worth of revenue was driven by apps and security services, while another 28% came from service work. What’s more, the company’s service arm is now sitting on $17.6 billion worth of “remaining performance obligations,” meaning that’s work that’s already been sold but not yet delivered.
The numbers are part of Cisco’s deliberate move toward more recurring, subscription-based revenue. By 2025, the company believes half of its business will be driven by subscriptions. Recurring subscription revenue of course means the company’s top line is rather predictable, while the bottom line is at least relatively stable. Further bear in mind that a more robust selection of turn-key software/hardware combo solutions also facilitates the sale of more hardware.
The other mostly overlooked argument for owning Cisco rather than a Nasdaq-based investment is that this isn’t yesteryear’s Cisco.
Sure, networking tools like routers and switches are still part of the mix. The company is branching into markets it’s historically not addressed, though. It now offers a so-called hybrid cloud platform called HyperFlex. For perspective, Mordor Intelligence estimates the hybrid cloud computing market will grow at an annual pace of nearly 19% through 2026, becoming a $145 billion yearly opportunity by the end of that stretch.
Cisco is also exposed to online collaboration, cybersecurity, and data analytics, just to name a few of the offerings now in its wheelhouse.
These aren’t exactly high-growth areas. But what Cisco lacks in big growth opportunities, it makes up for in reliability and above-average improvement. This year’s earnings estimates of $3.43 per share are more than 6% higher than last year’s bottom line, mirroring revenue growth. Next year’s projected progress is along those same lines, extending a bigger-picture, long-term streak of fiscal progress.
Best of all, you can plug into Cisco while shares are priced at only 15 times next year’s projected per-share profits of $3.67.
The Nasdaq is ripe for more selling
OK, great, but why is Cisco a remarkably better pick than the Nasdaq Composite or a Nasdaq-100 investment like the Invesco QQQ ETF (NASDAQ: QQQ)? The past few weeks’ performance provides part of the answer.
After rallying more than 130% from last March’s low to its early September high, the Nasdaq has pulled back about 5% over the past month. That’s more than a mild setback, but hardly the sort of corrective move needed to really hit the broad market’s proverbial reset button. All told, it could take something on the order of a 10% (or more) tumble for the market to make a good bottom and then renew its long-term rally. It’s a process that could take weeks to complete, though, and that’s assuming investors are willing to let it happen at all. If they’re not, just look for more market choppiness, at best.
Then there’s the broad market’s valuation. While there are a variety of ways to make such a measurement, most of them are now at uncomfortable levels. Warren Buffett’s “Buffett Indicator,” for instance, hit a record high early last month, indicating the stock market’s aggregate capitalization now stands at a jaw-dropping 142% of worldwide GDP; 100% is considered the norm.
The thing is, between Cisco’s recurring revenue bent and its recent pullback, it could be seen as a safe, value-type name offering shelter from such a marketwide storm. Indeed, despite a challenging tech environment, a Credit Suisse report recently upgraded the stock to an outperform, with analyst Sami Badri noting: “Investor sentiment is currently cautiously optimistic, but we believe the cautiousness will abate as CSCO executes on its long-term guidance while ramping its recurring revenue plans (software, subscriptions, etc.).” Badri’s price target of $75 per share is 36% better than the stock’s current price.
Bottom line? While the Nasdaq is long on risk and short on reward here, Cisco is long on reward and short on risk. Don’t overthink it.
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