Will Cisco Rule the Dow in 2012?

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It's been anything but a pleasant past year for Cisco Systems (NAS: CSCO) . The company suffered a series of setbacks in 2010, but its pain finally reached a crescendo in a February, when the company announced earnings that were off 8% year-over-year and pointed toward continuing struggles in the year ahead.

It wasn't Cisco's finest hour.

And the struggles early in the year exposed doubts that would haunt Cisco for months. Throughout 2011, Cisco's shares plummeted. Eventually, they reached bottom during the summer as investors panicked and sold off any companies with a whiff of risk. Cisco, with its large exposure to public-sector spending -- i.e., government spending -- was sold off especially aggressively.

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Cisco Systems Stock Chart by YCharts

Stepping on the toes of giants
Worse yet, Cisco's competitive position continued to be assaulted. The company pushed further into the server space with its Unified Computing System in hopes of finding growth outside networking. Areas like virtualization and blade servers are all the rage in today's technology world, and Cisco was looking for a piece of the pie.

However, that effort spurred former partners like Hewlett-Packard (NYS: HPQ) to take the offensive against Cisco. As competition from HP and traditional rival Juniper (NYS: JNPR) mounted, Cisco was forced to aggressively price its products to defend its market share. That led to a continuing erosion of margins throughout 2010 and 2011.

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Cisco Systems Gross Profit Margin Chart by YCharts

Not the best tech giant
This all led to Cisco's rank as the fifth worst-performing stock in the Dow Jones Industrial Average (INDEX: ^DJI) in 2011. However, it's worth noting that heading into the summer of 2011, Cisco was battling both HP and Bank of America for the inglorious title of worst stock in the Dow.

Green shoots on the horizon?
However, a late summer rally has lifted Cisco nearly 50% off the lows it reached in August of last year. As a beaten-down blue chip that has a dominant market share in a networking space that's set to see a fourfold increase in data traffic over the next four years, Cisco still sits at the center of one of the fastest growing areas of technology. Industry rival F5 Networks (NAS: FFIV) reported strong sales this week, offering further proof that networking sales are robust. That hints toward remaining ample opportunity for Cisco in networking; the company just needs to execute.

And there are positive signs that Cisco can execute. The company recently reorganized to better focus on its core routing and switching markets while ditching products in a misguided entry into the consumer space.

So, Cisco as the Dow stock of 2012?
I can see why investors would flock to Cisco, at 10 times forward earnings with a large cash balance. However, I believe investors looking for the top tech Dow performers would be advised to look at IBM and Intel before Cisco. Here's why:

  • IBM trades at a lower P/E ratio, and its forward earnings are comparable. Also keep in mind that forward earnings are adjusted -- i.e., they leave out things like stock-based compensation, something Cisco has historically been excessive with. IBM's also been executing on its five-year plan like clockwork. Simply put, IBM's leadership has gained my trust while Cisco CEO John Chambers has proved himself less than capable in recent years.
  • A lot of IT spending is moving overseas. Of new PC growth, an incremental two out of every three PCs is in emerging markets. Cisco sees only 16% of its growth from the Asian market, and its fastest growing market there isn't China but, curiously, Japan -- I'll let that sink in for a moment -- in its most recent quarter. While that means Cisco could outperform if the Asian growth story sputters this year, I'd rather stay aligned with companies like Intel and IBM, which have more exposure to countries with booming growth rates.

All in all, I think Cisco's done a reasonable job to turn the corner in 2011, but considering the mess the company made, that's not exactly high praise. If you're looking for the most bang for your buck in the technology space in 2011, you're best looking elsewhere.

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At the time this article was published Eric Bleeker owns shares of no companies listed above. The Motley Fool owns shares of Intel, IBM, Bank of America, and Cisco Systems.Motley Fool newsletter serviceshave recommended buying shares of Intel and Cisco Systems. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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