Cisco Systems, Inc. (NASDAQ:CSCO) is the architect of the internet. It produces the routers and switches without which there would be no internet. With an ever growing demand for high-speed internet traffic, Cisco Systems, Inc. (NASDAQ:CSCO) is well-positioned to satisfy that demand. In addition, the rise of internet video means that someone has to handle the higher bandwidth requirements. Bigger networks mean more routers and switches. Much of that new spending winds up in Cisco Systems, Inc. (NASDAQ:CSCO)’s pocket.
The opportunity
Back in the year 2000, Cisco Systems was the most valuable publicly traded company in the world. Its market cap was more than $500 billion. Mr. Market fell deeply in love with Cisco Systems, Inc. (NASDAQ:CSCO), sending it to a peak valuation of 155 times earnings. But since then, shares have lost about 70% of their value. Cisco’s business has become better, and its competitors such as Hewlett-Packard Company (NYSE:HPQ) and Alcatel Lucent SA (ADR) (NYSE:ALU) are almost invisible. At today’s price, Cisco Systems, Inc. (NASDAQ:CSCO) is a great buy for the following reason:
- It has a fortress-like balance sheet. The company currently has $8.8 of cash per share. This means that a third of each share is pure cash. That’s a hefty margin of safety.
- It dominates its sector – It owns 75% of the market for enterprise routers, which are used by large corporate clients, and it controls more than 65% of the Ethernet switch market. This strong dominance leads to inherently high barriers to entry for newer rivals. Contrast that to Hewlett-Packard Company (NYSE:HPQ) and Alcatel Lucent SA (ADR) (NYSE:ALU) — both of which don’t dominate any field. In fact, both are money-losing businesses. In 2012 alone, Alcatel lost a staggering $1.9 billion, while HP lost $12.5 billion. You could literally launch a Fortune 500 company just from these losses.
- Cisco is very cheap on an absolute level. It currently trades at a forward price-to-earnings of only 11.6x. That’s way cheaper than the average P/E of 18x of the S&P 500. And for that price, you receive a company with a 22% net profit margin. Hewlett-Packard Company (NYSE:HPQ) and Alcatel Lucent SA (ADR) (NYSE:ALU), on the other hand, boast a negative profit margin of 11% and a 15%, respectively.
How to take advantage of this opportunity
Investors can do one of two things — they can either buy the stock in the open market, or they can sell put options and pocket fat cash premiums on this trade. As of this writing, shares of Cisco Systems, Inc. (NASDAQ:CSCO) are trading at $24.60 and the January 2014, $24 strike puts are selling for $165. This translates into an immediate 6.9% gain on your investment by waiting six months until the January 2014 expiration.
To put it differently, investors can act as an insurance company and collect a premium of $165 for each option contract they sell. This contract, in turn, obligates them to buy shares of Cisco on the expiration day of January 2014 if shares are trading under $24. Repeat this trade two times a year, and you will have a 14% return annually.
