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One of the keys to watch when you either own or are considering buying a stock is what the insiders are doing. So when it comes to Cisco Systems (NASDAQ: CSCO) – once one of the growth powerhouses of the technology sector – the message appears to be, not “Buy,” and not “Hold,” but “Sell.” And, in fact, that’s my recommendation: I say you should sell Cisco stock.
To put a fine point on it, in the six weeks prior to the last weekend of June, nine different Cisco insiders sold 3,160,333 shares of their company’s stock, including CEO John Chambers, who sold 2,300,000 shares between May 19 and June 10.
What makes this all the more significant is that there were no insider purchases for the period. Yet, this doesn’t seem to have fazed the Wall Street analysts who follow the stock.
As of the end of June 2014, nine analysts rated Cisco stock a “strong buy,” 16 call it a “buy,” five say it’s going to “underperform,” 13 tell you to “hold” it, and only one rates it a “sell.” That puts me squarely in a tiny minority, but the correct minority.
Over the last 10 years, Cisco stock has generated a cumulative total return of just 12.4%, or a measly 1.2% a year. Over the last five, the numbers have been a bit better: a cumulative return of 40.6%, for an average of 7.0% per annum.
That’s an improvement, but nothing like what a respectable growth company should perform, much less one that used to set records.
What happened and is happening yet to Cisco? Two things: the company stopped firing on all cylinders, and rapid change in technology started to overtake it. To hear analysts tell it, Cisco became ponderously slow to react to market changes, the hardware made by different divisions didn’t always work well together, and a number of the acquisitions it made to upgrade its technology didn’t pan out.
Meanwhile, the new trend in the Internet is the viritualization of hardware – its replacement with software that makes all the hardware work better and faster. Cisco’s most threatening competitors are no longer other makers of Internet hardware, like Juniper Networks used to be, but companies like VMWare (NYSE: VMW), which is chiefly a software company focused on the Internet.
When it comes to Cisco stock, analysts talk about “the big turnaround,” by which they mean its changeover from a maker of hardware with embedded proprietary software, to more of a pure software company. Its targets are cloud computing, virtual Internet switches, and the “Internet of Things,” Internet links between all sorts of devices and systems, from manufacturing tools to healthcare devices, cars and trucks, and home entertainment, communication, heating and cooling systems.
Cisco CEO Chambers said in May that the Internet of Things market potential is as much as $19 billion. Meanwhile, investors are clamoring for Chambers, at the helm for 25 years, to give way to new leadership.
The question is, though, how big is Cisco’s turnaround going to be and when will it hit the big-time? Analysts’ consensus is that Cisco’s earnings will grow at a rate of 7.7% a year over the next five years, even less than the 9.6% it clocked over the last five, lackluster years.
CSCO stock trades for $22.93 and was paying an annual dividend of 76 cents, for a decent yield of 3.3%. To some observers, CSCO will enrich investors by as much as 10% a year, appreciation and dividends, for the next five years. That implies a price of about $36 by 2019, and for me, that’s just not enough.
I want to be sure I’m not overpaying for growth. The metric I rely on is a stock’s PEG ratio, its forward PE divided by its estimated future earnings growth. Since I’m looking for long-germ returns, I focus on the five-year estimated earnings growth rate. My magic number for a buy is a PEG of 1.2 or less; between 1.2 and 1.3, the ratio says “Hold.” Above 1.3, in my book, is a “Sell.”
CSCO’s PEG is now 1.57, a clear “Sell.” This isn’t to say that Cisco stock is going to crash. It may, in fact, grow, just not a rate that I think justifies the risk. Maybe that’s what Cisco’s insiders were thinking, too.
I’m going to keep my eye on the stock. Two things could make the PEG signal say “Buy”: a decline in the PE to around 9 or an increase in Cisco’s five-year earnings growth rate to 10%. Until then, I’ll be looking elsewhere for growth at a reasonable price.
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