Undervalued Cisco Systems, FCF/EV Yield 10%, Shareholder Yield 5%

One of the cheapest stocks in our Large Cap 1000 U.S. Stock Screener is Cisco Systems, Inc. (NASDAQ:CSCO).

Cisco Systems, Inc. (Cisco) designs and sells a range of products, provides services and delivers integrated solutions to develop and connect networks around the world. The company operates through three geographic segments: Americas; Europe, the Middle East and Africa (EMEA), and Asia Pacific, Japan and China (APJC).What Is The Definition Of The Blended P/E

A quick look at the company’s share price history over the past twelve months shows that the price is up 9%, but my valuation below indicates that Cisco is clearly undervalued. Here’s why.

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The following data is from the company’s latest financial statements, dated March 2017.

As always I like to start with the balance sheet. The latest balance sheet shows that Cisco has $8.116 Billion in cash and cash equivalents and $59.858 Billion in short term investments which equates to $67.974 Billion in cash and cash equivalents. Further down the balance sheet we can see that the company has short-term debt of $4.248 Billion and long-term debt of $28.222 Billion which equates to $32.470 in total debt. If we subtract the total debt from the total cash and cash equivalents we get $35.504 Billion in net cash and cash equivalents.

Cisco currently has a market cap of $156.587 Billion, so if we subtract the net cash and cash equivalents totaling $35.504 Billion we get an Enterprise Value of $121.147 Billion.

If we move over to the company’s latest income statements we can see that Cisco had $12.911 Billion in operating earnings over the trailing twelve months which means that the company is currently trading on an Acquirer’s Multiple of 9.37, or 9.37 times operating earnings. That places Cisco squarely in undervalued territory.

The Acquirer’s Multiple is defined as:

Enterprise Value/Operating Earnings*

*We make adjustments to operating earnings by constructing an operating earnings figure from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–income that a company does not expect to recur in future years–ensures that these earnings are related only to operations.

It’s also important to note that if we take a look at the company’s latest cash flow statements we can see that Cisco generated trailing twelve month operating cash flow of $13.693 Billion and had $1.022 Billion (ttm) in Capex. That equates to $12.671 Billion in trailing twelve month free cash flow, or a FCF/EV Yield of 10%. Further highlighting that Cisco is currently undervalued.

What also seems to get overlooked is that Cisco spent $3.856 Billion in share buy-backs and issued $774 million in new shares. The company also paid out trailing twelve month dividends totaling $5.372 Billion, all of which equates to a total shareholder yield of 5%.

Lastly, while a lot of analysts take a short term view of Cisco I believe it’s important to think about how the company is currently placed compared to its history. Cisco has trailing twelve month revenues of $48.510 Billion which is just 1.5% lower that the historical high of $49.247 Billion in FY2016. Its trailing twelve month net profits of $9.998 Billion are the highest in the company’s history with the exception of FY2016. Moreover, Cisco has consistently grown its book value per share every year from $5.16 in 2007 to $13.08 today. At the same time the company’s gross and operating margins are around historical highs of 63% and 25% respectively.

In addition to its very strong balance sheet the company has the ability to consistently grow free cash flow. Trailing twelve month free cash flow of $12.761 Billion is the highest on record thanks to increased operating cash flow and reductions in capital expenditures. Cisco is also a company that has shown that its shareholder friendly with its share buy-backs and dividend policy returning a 5% trailing twelve month shareholder yield.

In terms of Cisco’s valuation. The company is currently trading on a P/E of 15.7, a FCF/EV Yield of 10% and an Acquirer’s Multiple of 9.37, or 9.37 times operating earnings, all of which places Cisco in undervalued territory.

About The Large Cap 1000 U.S. Stock Screener (CAGR 18.4%)

Over a full sixteen-and-a-half year period from January 2, 1999 to July 26, 2016., the Large Cap 1000 U.S. stock screener generated a total return of 1,940 percent, or a compound growth rate (CAGR) of 18.4 percent per year. This compared favorably with the Russell 1000 Total Return, which returned a cumulative total of 259 percent, or 5.6 percent compound.

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The Acquirer’s Multiple® is the valuation ratio used to find attractive takeover candidates. It examines several financial statement items that other multiples like the price-to-earnings ratio do not, including debt, preferred stock, and minority interests; and interest, tax, depreciation, amortization. The Acquirer’s Multiple® is calculated as follows: Enterprise Value / Operating Earnings* It is based on the investment strategy described in the book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias Carlisle, founder of acquirersmultiple.com. The Acquirer’s Multiple® differs from The Magic Formula® Earnings Yield because The Acquirer’s Multiple® uses operating earnings in place of EBIT. Operating earnings is constructed from the top of the income statement down, where EBIT is constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations. Similarly, The Acquirer’s Multiple® differs from the ordinary enterprise multiple because it uses operating earnings in place of EBITDA, which is also constructed from the bottom up. Tobias Carlisle is also the Chief Investment Officer of Carbon Beach Asset Management LLC. He's best known as the author of the well regarded Deep Value website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Articles written for Seeking Alpha are provided by the team of analysts at acquirersmultiple.com, home of The Acquirer's Multiple Deep Value Stock Screener. All metrics use trailing twelve month or most recent quarter data. * The screener uses the CRSP/Compustat merged database “OIADP” line item defined as “Operating Income After Depreciation.”