If you have followed Cisco (CSCO) in the last few years, you will notice a big trend, a build up before the earnings and disappointment or even a crash after the earnings release. This is a classic “Buy on rumor, Sell on News” phenomenon. So why is this happening?
Three Major Risks against Cisco right now:
1. Mid to Long-term entry of more competition.
Cisco isn’t as revolutionary as it used to be and a lot of their products are for all intents and purposes “capped out.” Increasing capacity can only go so far. Cisco is a profitable company, because their supplies haven’t breached the barrier to entry, but if it ever happens, it will be a disaster. This scenario is unlikely to affect “Ways to Play” below.
2. They are viewed as an outdated and possibly “uncool” company.
Cisco is no Apple. It has good ol’ John Chambers as CEO, and it feels that the company is becoming dated.
3. The market doesn’t a feel for the overall direction of the company.
With a P/E of 12.35, you think it would be a bargain stock, but sadly there is no real overlook other than “let’s hope they keep doing what they are doing.”
Time to Step Back
It’s not all gloom and doom for Cisco (CSCO), in fact I would argue it’s a fairly good buy. The internet is rapidly expanding. Universities, businesses, and even developing countries are buying infrastructure, and Cisco has the capability. As I stated, P/E of roughly 12.35, and annual revenues have been growing. All Cisco needs is a great quarter to jump a solid couple of dollars a share. Doing “okay” or “pretty good” is simply not enough. The street doesn’t want same old same old for Cisco. They want to see real, material growth. Cisco also has cut some employees, which might make a spike in earnings, but the street is likely to discount some of this effect.
Ways to Play CSCO
Straight LEAP Option (best option in my opinion): $22, Jan 2016, costs roughly $2.82 (roughly 12.5% of the stock). You make this play if you are foreseeing growth in the next 2 years. I’ve been harping on Cisco for a while now, and sadly the premium for these LEAPs have gone up a little bit.
Leap Call Spread: $20/22, Jan 2015, less downward protection, but pays about 60% return. (Cost $1.25 per contract, $2 / $1.25 = 1.6x)
Leap Call Spread: $17/$20, Jan 2015, more downward protection, pays about 22.4% return. This is a pretty solid play in my eyes. I think the stock is likely to stay above the $20 point in the next 11 months.
Leap Call Spread: $25/30, Jan 2016, at a cost of roughly $1.00 per contract, you are looking at a 5x situation if CSCO performs well over the next two years. You might think this is a hail mary, but I would put the chances of Cisco finishing around $30 a share in the next two years above 20%.