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The Most Undervalued Tech Stock On The Planet

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One of my favorite scenes from the brilliant Steve Martin film The Jerk was when the deranged sniper played by C. Emmett Walsh is firing at Martin’s character, the hapless gas station attendant Navin Johnson, yelling “Die milk face!” The sniper’s aim is poor and as the bullets whiz past him, Martin yells, “He hates these cans!”

Having been a long-time bull on the seven-million-pound networking gorilla Cisco Systems (Nasdaq: CSCO)and for quite a while, I’ve felt a little like Navin Johnson where the market is the sniper and I’m running around yelling “It hates this stock!”

What am I missing?

Big Tech, Low Price
On average, the company has grown earnings per share at an 11% annual rate over the last four years. The common dividend per share has grown at a 13% annual rate for the same time period. Total cash per share is a staggering $14.12, representing 45% of Cisco’s current share price.

Rationally, this is a stock investors looking for high quality, blue-chip brand names should own. But investors and markets are rarely, if ever, rational.The biggest concern the herd has is revenue weakness. For fiscal year 2017 (Cisco’s ends in July), the company finished with $48 billion in annual sales, a 2.43% dip from 2016’s $49.2 billion. What was the reason for this? Over the last few years, the company has been concentrated on growing its software and services businesses. One component of this transformation is the company’s switch from a contract to a subscription revenue model.

While 45% of the company’s revenue mix still relies on selling its market-leading switching and routing hardware (60.7% globally for Ethernet switching and 70% for enterprise routers), 24% of Cisco’s revenue now falls under the “service” column. In its reporting, the company refers to this as “deferred revenue,” which is defined as a product or service not yet delivered to a customer and will show up as a liability on a company’s balance sheet.

In Cisco’s case, if a customer is paying on a monthly basis for a subscription service, the fees they will pay in October will not be recognized until then therefore it will not be included in a mid-year earnings report. However, in time, the company’s revenue stream becomes much more predictable regardless of the accounting treatment.

In the company’s most recent annual report, subscription and software deferred revenues mushroomed 50% from $3.308 billion in 2016 to $4.971 billion for the end of the 2017 fiscal year. That’s growth, hands down.

Like every smart, successful big tech company, Cisco is executing on the transition from hardware to software and services which over time will lead to higher margins and increased earnings per share (EPS).

To further grow in this space, Cisco is dipping into its massive $70 billion cash pile to fund acquisitions. Most recently, the company announced plans to acquire hyper-convergence software firm Springpath for a measly $320 million.

Putting company-specific minutiae aside, the real story is in the “Internet of Things” (IoT) big picture. According to Business Insider’s BI Intelligence, by the year 2020, 34 billion devices will be connected to the Internet. And that’s not just computers and mobile devices, it’s cars, televisions, farming irrigation systems, and refrigerators. You name it — it will be connected.

By 2020, it’s estimated that businesses will have spent nearly $9 trillion on global IoT investments. Cisco’s market position in networking and related services and their ability to execute successfully ensures that a decent portion of that $9 trillion will find its way into the company’s cash register.

Risks To Consider: The biggest risk facing Cisco is their ability to execute. A significant business shift from hardware to software and services is never a simple task for a huge, mature, tech company. However, based on reports and the growth trajectory of the areas they want to move toward, it would seem they are doing everything right.

The macro challenge facing Cisco and all capex-dependent tech companies is the overall health of the economy. A recession can put the brakes on growth faster than a jack rabbit on a date. But the Internet has become a business necessity, almost a utility. The notion that everything Cisco sells is integral to accessing that utility provides a relatively deep moat of defense even in an economic downturn.

Action To Take: Investors looking to add technology names but discouraged by the lofty valuations in the FAANG names (Facebook, Apple, Amazon, Netflix, Google), would do well by picking up bargain priced shares of Cisco.

Currently, the stock trades around $31.55 (an 8.8% discount to its 52-week high) with a forward P/E of 13 and a growing 3.7% dividend yield. If the company continues to successfully shift its business model and maintains the growth of its subscription based revenue stream, shares could reach a 12- to 18-month price target of $38.

With the dividend, the result would be a 24% total return. I would encourage investors to hold the stock longer, though, considering its solid dividend and dividend growth history.

Editor’s Note: With reports of deteriorating production, performance, and revenue… this high-profile CEO is ditching his auto empire. Now he’s set his sights on an even more lucrative business. And if you jump in at the ground level of this opportunity you can ride it upward to sky-high profits. Grab a piece of this $1.3 trillion industry in the making today.

Adam Fischbaum owns shares of CSCO.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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Today’s Market Looks Like It Did At The Peaks Before Last 13 Bear Markets

The US stock market today looks a lot like it did at the peak before all 13 previous price collapses. That doesn’t mean that a bear market is imminent, but it does amount to a stark warning against complacency.

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h/t ZeroHedge 

The US stock market today looks a lot like it did at the peak before all 13 previous price collapses. That doesn’t mean that a bear market is imminent, but it does amount to a stark warning against complacency.

The U.S. stock market today is characterized by a seemingly unusual combination of very high valuations, following a period of strong earnings growth, and very low volatility.

What do these ostensibly conflicting messages imply about the likelihood that the United States is headed toward a bear market in stocks?

To answer that question, we must look to past bear markets. And that requires us to define precisely what a bear market entails. The media nowadays delineate a “classic” or “traditional” bear market as a 20% decline in stock prices.

That definition does not appear in any media outlet before the 1990s, and there has been no indication of who established it. It may be rooted in the experience of Oct. 19, 1987, when the stock market dropped by just over 20% in a single day. Attempts to tie the term to the “Black Monday” story may have resulted in the 20% definition, which journalists and editors probably simply copied from one another.

Origin of the ‘20%’ figure

In any case, that 20% figure is now widely accepted as an indicator of a bear market. Where there seems to be less overt consensus is on the time period for that decline. Indeed, those past newspaper reports often didn’t mention any time period at all in their definitions of a bear market. Journalists writing on the subject apparently did not think it necessary to be precise.

In assessing America’s past experience with bear markets, I used that traditional 20% figure, and added my own timing rubric. The peak before a bear market, per my definition, was the most recent 12-month high, and there should be some month in the subsequent year that is 20% lower. Whenever there was a contiguous sequence of peak months, I took the last one.

Referring to my compilation of monthly S&P Composite and related data, I found that there have been just 13 bear markets in the U.S. since 1871. The peak months before the bear markets occurred in 1892, 1895, 1902, 1906, 1916, 1929, 1934, 1937, 1946, 1961, 1987, 2000 and 2007. A couple of notorious stock-market collapses — in 1968-70 and in 1973-74 — are not on the list, because they were more protracted and gradual.

CAPE ratio

Once the past bear markets were identified, it was time to assess stock valuations prior to them, using an indicator that my Harvard colleague John Y. Campbell and I developed in 1988 to predict long-term stock-market returns. The cyclically adjusted price-to-earnings (CAPE) ratio is found by dividing the real (inflation-adjusted) stock index by the average of 10 years of earnings, with higher-than-average ratios implying lower-than-average returns. Our research showed that the CAPE ratio is somewhat effective at predicting real returns over a 10-year period, though we did not report how well that ratio predicts bear markets.

This month, the CAPE ratio in the U.S. is just above 30. That is a high ratio. Indeed, between 1881 and today, the average CAPE ratio has stood at just 16.8. Moreover, it has exceeded 30 only twice during that period: in 1929 and in 1997-2002.

But that does not mean that high CAPE ratios aren’t associated with bear markets. On the contrary, in the peak months before past bear markets, the average CAPE ratio was higher than average, at 22.1, suggesting that the CAPE does tend to rise before a bear market.

Moreover, the three times when there was a bear market with a below-average CAPE ratio were after 1916 (during World War I), 1934 (during the Great Depression) and 1946 (during the post-World War II recession). A high CAPE ratio thus implies potential vulnerability to a bear market, though it is by no means a perfect predictor.

Earnings to the rescue?

To be sure, there does seem to be some promising news. According to my data, real S&P Composite stock earnings have grown 1.8% per year, on average, since 1881. From the second quarter of 2016 to the second quarter of 2017, by contrast, real earnings growth was 13.2%, well above the historical annual rate.

But this high growth does not reduce the likelihood of a bear market. In fact, peak months before past bear markets also tended to show high real earnings growth: 13.3% per year, on average, for all 13 episodes. Moreover, at the market peak just before the biggest ever stock-market drop, in 1929-32, 12-month real earnings growth stood at 18.3%.

Another piece of ostensibly good news is that average stock-price volatility — measured by finding the standard deviation of monthly percentage changes in real stock prices for the preceding year — is an extremely low 1.2%. Between 1872 and 2017, volatility was nearly three times as high, at 3.5%.

Low volatility

Yet, again, this does not mean that a bear market isn’t approaching. In fact, stock-price volatility was lower than average in the year leading up to the peak month preceding the 13 previous U.S. bear markets, though today’s level is lower than the 3.1% average for those periods. At the peak month for the stock market before the 1929 crash, volatility was only 2.8%.

In short, the U.S. stock market today looks a lot like it did at the peaks before most of the country’s 13 previous bear markets. This is not to say that a bear market is guaranteed: Such episodes are difficult to anticipate, and the next one may still be a long way off. And even if a bear market does arrive, for anyone who does not buy at the market’s peak and sell at the trough, losses tend to be less than 20%.

But my analysis should serve as a warning against complacency. Investors who allow faulty impressions of history to lead them to assume too much stock-market risk today may be inviting considerable losses.

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You don’t want to miss this new trend

Over the past six years, U.S. stocks have screamed higher…

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Original Link | The Crux


From Ben Morris, Editor, DailyWealth Trader:

Over the past six years, U.S. stocks have screamed higher…

They’ve doubled the performance of stocks around the rest of the world — a 116% gain compared with a 57% gain (*all numbers in this essay are as of Sept. 12).

But recently, that situation reversed…

Over the past four months, non-U.S. stocks have more than doubled the gains in U.S. stocks (8.5% compared with 4.1%). And yesterday, the market gave us a sign that big gains are likely still to come.

If you’ve been reading DailyWealth Trader (DWT), you know we’ve encouraged readers to own foreign stocks for years…

Mostly, this has been because investors around the world suffer from something called “home-country bias.” Nearly all the businesses they buy are based in their home countries… And they either ignore or fear opportunities outside their countries’ borders.

This hasn’t been a problem for U.S.-based investors lately… But now that foreign stocks are outperforming – and now that U.S. stocks are no longer cheap – it’s an even better idea to put some of your money to work in other markets.

Plus, as I noted above, the market just gave us a sign that the gains in non-U.S. stocks will likely continue…

Yesterday, the MSCI World ex USA Index hit a new one-year high. The index is made up of more than 1,000 businesses based in 22 countries. And in the past, new one-year highs were a great sign.

The table below shows how the index has performed after hitting a one-year high. Over the past 33 years, it has happened more than 600 times.

One year later, the index was higher 76.9% of the time… And the median return was 11.5%. (That means you would have made 11.5% or more exactly half of the occurrences.) You can also see the rate of 10%-plus gains and 5%-plus losses…

dwttable919

These are great odds. Based on history, if you were to buy a basket of non-U.S. stocks today, you would have a 54% chance of making 10% or more over the next year… and just a 14% chance of losing 5% or more.

Compare that with the index’s returns after all periods (essentially, buying the index at random). The average and median returns were lower across all time frames. The chances of a positive return were seven to 10 percentage points lower. The frequency of 10%-plus gains after one year was much lower… And the frequency of 5%-plus losses was much higher.

dwttable2919

History presents a clear picture… Buying non-U.S. stocks after new one-year highs is a good idea.

You can see how a handful of foreign stock funds have performed relative to the U.S. benchmark S&P 500 Index over the past year in the chart below…

0912_spx_globalstocks

All but Greek stocks are at or just shy of new highs.

If you prefer to keep it simple, you can also consider buying a fund like the Vanguard FTSE All-World ex-US Fund (VEU). It is the largest exchange-traded fund dedicated to diversified non-U.S. stocks. It holds stocks from 54 different countries, with larger weightings in developed markets and smaller weightings in emerging markets.

VEU just hit a new high, too.

If you’ve been dragging your feet on buying foreign stocks, you’ve missed out on great gains lately… But you haven’t “missed the boat.”

Non-U.S. stocks have underperformed U.S. stocks for years. And that situation has started to change only recently. Now that these stocks are hitting new highs, it’s even more likely than before that we’ll see double-digit gains in the year to come.

I strongly recommend you participate.

Regards,

Ben Morris

Crux note: Ben has recommended a few great ways to safely invest in foreign stocks today. So far, his readers are up on all of them – 19%, 31%, 16%, and 1%, respectively. And his top open recommendation just hit 150% since February. For a limited time, you can access all of Ben’s top ideas with a risk-free trial subscription. Get the details right here.

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Today the music stops

After months of preparing financial markets for this news, the Federal Reserve is widely expected to announce that it will finally begin shrinking its $4.5 trillion balance sheet.

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Today’s the day.

After months of preparing financial markets for this news, the Federal Reserve is widely expected to announce that it will finally begin shrinking its $4.5 trillion balance sheet.

I know, that probably sound reeeeally boring. A bunch of central bankers talking about their balance sheet.

But it’s phenomenally important. And I’ll explain why-

When the Global Financial Crisis started in 2008, the Federal Reserve (along with just about every central bank in the world) took the unprecedented step of conjuring trillions of dollars out of thin air.

In the Fed’s case, it was roughly $3.5 trillion, about 25% of the size of the entire US economy at the time.

That’s a lot of money.

And after nearly a decade of this free money policy, there is more money in the financial system than ever before.

Economists have a measure for money supply called “M2”. And M2 is at a record high — nearly $9 trillion higher than at the start of the 2008 crisis.

Now, one might expect that, over time, as the population and economy grow, the amount of money in the system would increase.

But even on a per-capita basis, and relative to the size of US GDP, there is more money in the system than there has ever been, at least in the history of modern central banking.

And that has consequences.

One of those consequences is that asset prices have exploded.

Stocks are at all-time highs. Bonds are at all-time highs. Many property markets are at all-time highs. Even the prices of alternative assets like private equity and artwork are at all-time highs.

But isn’t that a good thing?

Well, let’s look at stocks as an example.

As investors, we trade our hard-earned savings for shares of a [hopefully] successful, well-managed business.

That’s what stocks represent– ownership interests in businesses. So investors are ultimately buying a share of a company’s net assets, profits, and free cash flow.

Here’s where it gets interesting.

Let’s look at Exxon Mobil…

In 2006, the last full year before the Federal Reserve started any monetary shenanigans, Exxon reported $365 billion in revenue, profit (net income) of nearly $40 billion and free cash flow (i.e. the money that’s available to pay out to shareholders) of $33.8 billion.

At the time, the company had $6.6 billion in debt.

Ten years later, Exxon’s full-year 2016 revenue was $226 billion, net income was $7.8 billion, free cash flow was $5.9 billion and the company had an unbelievable debt level of $28.9 billion.

In other words, compared to its performance in 2006, Exxon’s 2016 revenue dropped nearly 40%, due to the decline in oil prices.

Plus its profits and free cash flow collapsed by more than 80%. And debt skyrocketed by over 4x.

So what do you think happened to the stock price over this period?

It must have gone down, right? I mean… if investors are essentially paying for a share of the business’ profits, and those profits are 80% less, then the share of the business should also decline.

Except — that’s not what happened. Exxon’s stock price at the end of 2006 was around $75. By the end of 2016 it was around $90, 20% higher.

And it’s not just Exxon. This same curiosity fits to many of the largest companies in the world.

General Electric reported $13.9 billion in free cash flow in 2006. Last year’s free cash flow was NEGATIVE.

Plus, the company’s book value, i.e. its ‘net worth’, plummeted from $122 billion in 2006 to $77 billion in 2016.

So investors’ share of the free cash flow is essentially worthless, while their share of the net assets has also fallen dramatically.

GE’s stock was actually down slightly in 2016 compared to 2006. But the minor stock decline is nothing compared to the train wreck in the company’s financial statements.

Between 2006 and 2016, McDonalds reported only a tiny increase in revenue. And in terms of bottom line, McDonalds 2016’s profit was about 30% higher than it was in 2006.

McDonalds’ debt soared from $8.4 billion to $25.8. And the company’s book value, according to its own financial statements, dropped from $15.8 billion to NEGATIVE $2 billion.

So over ten years, McDonald’s saw a 30% increase in profits, but took on so much debt that they wiped out shareholders’ book value.

And yet the company’s stock price has TRIPLED.

Coca Cola. IBM. Johnson & Johnson.

Company after company, we can see businesses that are performing marginally better (or in some cases WORSE). They’ve taken on FAR more debt than ever before.

Yet their stock prices are insanely higher.

How is that even possible? Why are investors paying more money for shares of a business that isn’t much better than before?

There’s really only one explanation: there’s way too much money in the system.

All that money the Fed printed over the years has created an enormous bubble, pushing up the prices of assets to record highs even though their fundamental values haven’t really improved.

As the Wall Street Journal reported yesterday, “Financial assets across developed economies are more overvalued than at any other time in recent centuries,” i.e. at least since 1800.

Investors are paying far more than ever for their investments, but receiving only marginally more value in return. And they’re actually excited about it.

This doesn’t make sense. We don’t get excited to pay more and receive less at the grocery store.

But when underperforming assets fetch top dollar, people feel like they’re wealthier. Crazy.

Today the Fed should formally announce that after nearly a decade, it’s going to start vacuuming up a lot of that money it printed in 2008.

Bottom line: they’re going to start cutting the lights and turning off the music.

And given the enormous impact that this policy had on asset prices, it would be foolish to think its reversal will be consequence-free.

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