Analysis: CSCO PANW

After you receive this Alert, we will be initiating a position in Cisco (CSCO) , buying 500 shares at roughly $45.52. Following the trade, CSCO will represent 0.84% of the portfolio.

We will call up Cisco from bullpen to upgrade the portfolio into stocks we believe are well positioned to recover from the recent market selloff. You can read our initial bullpen Alert on the company here. The company's fiscal year 2018 annual report can be found at the site here.

This is a name we have held before, exiting prematurely in mid-2017 due to our concerns that its transition from one-time hardware sales to recurring software hit a setback. Since that time, the company has executed on its business transformation, delivering strong results with its products that serve the multi-cloud environment. This was most easily evidenced last quarter, when the company delivered a 1% point increase in recurring revenue as a percent of total revenue (32%), increased deferred product revenue from recurring software and subscription by 23% year over year to $6.1 billion, and increased subscriptions as a percent of software revenue by 5 percentage points to 56%. On top of this, management's first quarter fiscal 2019 guidance called for top line growth between 5 to 7%, which implies continued acceleration from the previous quarter, and earnings per share guidance above consensus. It is rare to find companies of this size that are accelerating and transforming successfully like this.

Thanks to the market-wide selloff, CSCO has drifted back towards levels when it reported this strong quarter with exciting guidance, meaning that we are getting the quarter and upside guidance at a small additional cost.

The thinking here is also in line with the decision to take a position in Palo Alto (PANW) as we believe the company's increasing focus on cyber security will prove a demand driver for years to come. To this point, we also value Cisco for its Encrypted Traffic Analytics (ETA) platform, which thanks to Cisco's Digital Network Architecture (DNA) can detect and remove malicious software, even if it is being hidden by encryption software on computer networks and is first of its kind in the industry. Additionally, while the overall transition is key to longer-term growth, we believe now to be a good time to initiate the position because DRAM prices, a major input cost for the company, are coming down based on commentary from its providers.

One final point is that we find Cisco's value/defensive-like characteristics attractive. This is based on the stock's 15x next-twelve-month earnings multiple, its solid ~2.90% dividend yield, its steady diet share repurchases, and the $46.5 billion in cash and equivalents it ended with last quarter. On the cash front, this war chest was made readily deployable because of changes to the tax code which allowed Cisco to repatriate $67 billion back in February.

Lastly, we are initiating the position with a $52 price target, which reflects roughly 16 times consensus fiscal 2020 earnings. That being said, we believe there is room for both multiple expansion and earnings growth based on continued execution from management.