A Citi analyst just downgraded Cisco — here's why we're sticking with the stock

Published Tue, Apr 12 20222:58 PM EDT

Veteran Citi analyst Jim Suva downgraded Cisco Systems (CSCO) to sell from neutral Tuesday, the morning after we bought 200 shares of the technology company. We admittedly were caught off guard by Suva's note. We've now had a chance to read through it — and we remain believers in the company's story and stock. "The relative valuation of Cisco is, I think, the lowest I've ever seen it," Jim Cramer said during Tuesday's Morning Meeting. "But the long knives are out for tech. When I say that, what I mean is these analysts are itching because they're afraid, and we're not going to do things out of fear." Understanding the call Supply chain concerns played a prominent role in Suva's decision to rate Cisco a sell. He also expressed concerns about competition, specifically from Juniper Networks (JNPR) and Arista Networks (ANET). Here's what he wrote: [Current] supply chain challenges are more of a headwind for Cisco than for the company's peers as peers have been ordering and building for upside to gain share from Cisco. We believe competitors have been able to procure more parts than Cisco, which is hurting Cisco's sales and market share. Suva stressed he has "no financial cash flow or going concern issues with Cisco." Rather, the analyst said he believes that as a result of inventory shortages and market share losses, Cisco will experience "valuation multiple compression." In other words, Suva believes investors will want to pay a lower price for Cisco's future earnings. That's why he cut his valuation multiple on Cisco to 11.9 times forward earnings from 17. Citi's price target falls along with it to $45 per share, down from $65. Where we stand The Club does not share Suva's view on valuing Cisco. The analyst's target of 11.9 times forward earnings is a 19.6% discount to the stock's five-year average of 14.8. Cisco currently trades at 14.6 times forward earnings. At worst, we think Cisco's forward price-to-earnings ratio should stay near that five-year average. However, we actually believe Cisco will expand its multiple as the computer networking company continues its grow its software and services revenue under CEO Chuck Robbins. It's a multi-year process, but management believes it's beginning to pay off . Investors are typically apply a higher multiple to software revenue because it is higher margin and more stable than hardware sales, which tend to be more cyclical. There's no question supply chain issues have been an obstacle that Cisco has needed to navigate this year. At the same time, it's important to remember just how strong Cisco's software orders looked in February, when it posted better-than-expected second-quarter earnings . In the second quarter, Cisco's short-term remaining performance obligation, or RPO, checked in at $16.3 billion . That's the revenue the company expects to recognize in the next 12 months. There also was another $2 billion software backlog, not included in the short-term RPO, within a broader $14 billion product backlog. We'll get another look at these figures May 18, when Cisco reports third-quarter numbers after the bell. Value tech Cisco fits within the Club's mantra of owning profitable companies that "make stuff or do things" and return some of those earnings back to shareholders through dividends, buybacks or both. The stock has a dividend yield just under 3%, and in February, Cisco's board gave the green light to a $15 billion increase to its share buyback program. Those are two reasons we added to our Cisco position Monday, along with generally finding the stock attractive around $53 per share. Reminder: In late March, we sold 200 shares at roughly $56.12 apiece . We locked in some profits and indicated we'd be buyers again below $54. Within the technology sector, in particular, Cisco is the kind of stock we want to own at this moment. Inflation is running at its hottest level in decades, with March's consumer price index jumping 8.5% on an annual basis , the largest year-over-year jump since December 1981. The Federal Reserve is embarking on an aggressive tightening regime in an attempt to tamp down on that inflation. However, high-multiple growth stocks like Nvidia (NVDA) are more vulnerable to selling pressure in that type of monetary policy environment. That's why we've been pivoting our portfolio in recent days, and value-oriented tech is one area we want to be in. (Jim Cramer's Charitable Trust is long CSCO, NVDA. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Cisco logo exhibited during the Mobile World Congress, on February 28, 2019 in Barcelona, Spain.

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