BOSTON ( TheStreet) -- Networking-gear giant Cisco ( CSCO) has dropped 7.6% in a month as the Dow rallied 5.6%. Poor guidance following last quarter's results led to a sell-off.
With earnings season under way as of yesterday, it's time to review Cisco as its industry leads the pack in profit growth. Research firm Morningstar awards Cisco a superlative five-star rating, auguring 44% upside. Cisco reports earnings a month from now.
Cisco's quarterly adjusted profit increased 17% year-over-year to 42 cents, exceeding analysts' consensus estimate by 5.8%. The San Jose, Calif.-based company also beat on the top-line, yet its stock tumbled 16% around the earnings announcement due to lower-than-anticipated forward guidance from management. Cisco's quarterly gross margin narrowed from 69% to 67%, and its operating margin contracted from 24% to 22%. Value-focused Morningstar argues that, given Cisco's market share and competitive advantages, its stock sells at a discount to fair value. Cisco holds 70% market share in Ethernet switches while the next-biggest competitor, Hewlett-Packard ( HPQ), has just 10%. Cisco also boasts lead market share in the router category, but Juniper Networks ( JNPR) is a competitive threat and China-based Huawei is generating momentum in critical emerging markets, according to Morningstar. Still, overseas expansion will generate significant profits in the next decade as the global economy rebalances. Though bullish, Morningstar believes management's 12% to 17% long-term growth target is "overly aggressive for such a mature firm." Morningstar also says a recent move into data-center blade servers is a strategic misstep, given the low profit margins offered by such products and the possibility of irritating longstanding partners with a foothold in the market. There is already evidence of such backlash, according to Morningstar. Also, analysts are concerned with overly acquisitive behavior. Cisco has nearly $24 billion of net liquidity (cash minus debt). Given the strong performance of equity markets, it may be ill-advised to pay premiums to grow inorganically. However, these caveats aside, Cisco remains a notably undervalued stock and Morningstar's $30 target suggests 44% of upside to fair value. Shares sell for a trailing earnings multiple of 15, a forward earnings multiple of 11, a book value multiple of 2.6, a sales multiple of 2.8 and a cash flow multiple of 11, 50%, 43%, 23%, 27% and 40% discounts to communications equipment industry averages. Cisco's trailing earnings multiple reflects a 24% discount to the five-year average. In addition to Morningstar, 70% of Wall Street analysts rate Cisco "buy."