Poor Earnings Could Drag Cisco Stock Below $40

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Cisco Systems stock (NASDAQ: CSCO) is down around 5% since the beginning of 2020, and at the current price of $45 per share, we believe that Cisco stock has around 15% potential downside.

Why is that? Our belief stems from the fact that Cisco stock has rallied almost 40% from the low seen in March 2020, around a year ago. Further, after posting weak Q2 2021 numbers, and with demand still not up to pre-Covid levels, we believe Cisco stock could drift lower. Our dashboard What Factors Drove 4% Change In Cisco Stock Between 2018 And Now? provides the key numbers behind our thinking, and we explain more below.

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Cisco stock’s rise since late 2018 came despite a drop in revenues from $51.9 billion in FY 2019 to $49.3 billion in FY 2020. Net margins grew marginally from 22.4% to 22.7%, but net income dropped around 3.5%. This, combined with a 4% drop in the outstanding share count, led to earnings per share (EPS) rising marginally from $2.63 to $2.65.

In addition, Cisco’s P/E (price-to-earnings) ratio rose from around 16x in 2018 to 18x in 2019, and has since dropped to 17x. Given Cisco’s weak Q2 2021 earnings, there is further possible downside risk for Cisco’s multiple, especially when compared with previous years: P/E of 16x as recently as the end of 2018.

So what’s the likely trigger and timing to this downside?

The global spread of coronavirus and the resulting lockdowns have led to a drop in semiconductor and equipment demand across a variety of industries. This is evident from Cisco’s Q2 2021 earnings, where revenue came in at $11.96 billion, down marginally from $12 billion in Q2 2020. As operating expenses rose a little faster than the drop in revenue, operating income dropped from $3.38 billion to $3.22 billion. A slightly higher effective tax rate (21.8% in Q2 ’21 vs 18.6% in Q2 ’20) further weighed on net income, which dropped to $2.55 billion from $2.89 billion, driving EPS down a little over 10% to $0.60.

Further, with revenue growth expected to remain weak in the near to medium term, profitability could take a bigger hit. We believe the stock will see its P/E multiple decline from the current level of 17x to around 16x, which combined with a reduction in revenues and margins could result in the stock price shrinking to as low as $38, a downside of around 15% from the current price around $45.

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