Cisco Systems Astonishes Wall Street, but Not in the Right Way

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Following a day of losses, stocks rebounded to a record high on Wednesday, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average gaining 0.8% and 0.4%, respectively. Both indexes are sitting at all-time highs on the eve of Fed chair nominee Janet Yellen's appearance before Congress.

Dow component Cisco Systems reported results for its fiscal first quarter ended October 26 after the closing bell. The market's initial verdict, judging by the stock's chart in the after-hours session, is damning, with the shares losing 10.4% at 7:59 p.m. EST.

If that decline carries through to tomorrow's session in any significant manner, it will weigh on the Dow, despite the fact that, with a share price in the $ 20 range, Cisco Systems is not one of the index's most important components. Keep in mind the potential knock-on impact on other stocks in the technology sector: Shares of IBM -- which is one of the Dow's heaviest components -- were down roughly 1% in the after-hours session.

What exactly was the problem with Cisco Systems' earnings report? It certainly wasn't the announcement that the networking specialist and technology spending bellwether will increase its share repurchase program by a whopping $15 billion, nor the fact that it actually beat Wall Street expectations with non-GAAP earnings per share of $0.53, two cents ahead of the consensus estimate.

Instead, the problem lay with Cisco's guidance for the current quarter and the full year, as the following table illustrates:


Cisco's Guidance

Wall Street Consensus Estimate

Fiscal second-quarter EPS



Fiscal second-quarter revenues

Year-on-year decline of between 8% and 10%

+4.1% year-on-year growth to $12.6 billion

Fiscal 2014 EPS



Source: Barron's, Yahoo! Finance.

Summing up Wall Street's reaction, one analyst participating in the earnings conference call could not contain his astonishment at the numbers Cisco provided during the Q&A session, observing: "Your guidance is very low... I've never seen such a low number. Why are you guiding so low?" 

Cisco CEO John Chambers pointed to several factors, including expectations of a challenging next several quarters in emerging markets and that the company would be "taking a hit in [the] set top box business in the next few quarters." Later in the call, Chambers added that the downturn in demand in emerging markets was broadly based and not due to one or two countries.

Last week, Cisco's stock substantially outperformed the market with a 4.2% rise, perhaps in anticipation of a better-than-expected earnings report; however, it looks likely that they will give all of that back and more tomorrow. Cisco shares are trailing the market this year and, at just 11.5 times next 12 months' earnings-per-share estimate, they trade at a significant discount to the S&P 500's price-to-earnings multiple. Chambers tried to end this afternoon's call on a reassuring note, asserting that "we have all the pieces here... I don't think it's a structural issue," but today's report certainly won't help close that valuation gap any sooner. Quite the contrary.

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool recommends Cisco Systems and owns shares of IBM. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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