Cisco GSX (our annual sales meeting) was, as always, an outstanding experience! There was one line spoken on the main stage that got the largest applause I have seen in years – and deservedly so. Gerri Elliott (Cisco’s new sales and marketing boss, and also my boss’s boss’s boss’s boss’s boss’s boss’s boss :/ – wish I was closer to the top! ) pointed out to Chuck Robbins on stage that this meeting marked his 3-year anniversary as Cisco CEO and in that time, Cisco stock price is up… 82%!   That brought the house down, as it should.

82% seemed incredible to me when I heard it. I know the price has risen – but wow, a near doubling? That means under Chuck’s leadership Cisco has added $90B of market cap.  I know that’s small compared to the top 5 stocks, but it is an amazing amount of money in its own right. John Chambers, when he became CEO in 1995 had a $5B company, and left it 20 years later at $130B — $125B of market cap in 20 years.  Chuck has done $90B in just 3 years.

So, how it is possible that Cisco stock has risen so much in 3 years?  From a sales point of view we have not materially grown sales at all in the last 5 years, not even at the rate of inflation, even with new acquisitions.  Here are the numbers for the last 10 years of Cisco earnings:

Quarter Ending	revenue ($m)	net income ($m)	dividends paid	Shares outstanding (billions)	stock price on Q end	market cap ($B)
7/28/18	12,840	3,800	0.33	4.7	47.15	221.605
4/28/18	12,463	2,691	0.33	4.8	42.7	204.96
1/27/18	11,887	2,322	0.29	4.9	44.78	219.422
10/28/17	12,136	2,394	0.29	5	35.88	179.4
7/29/17	12,133	2,424	0.29	5	32.21	161.05
4/29/17	11,940	2,515	0.29	5	31.53	157.65
1/28/17	11,580	2,348	0.26	5	34.18	170.9
10/29/16	12,352	2,322	0.26	5	29.82	149.1
7/30/16	12,638	2,813	0.26	5	31.44	157.2
4/30/16	12,000	2,349	0.26	5	29.05	145.25
1/23/16	11,927	3,147	0.21	5.1	26.18	133.518
10/24/15	12,682	2,430	0.21	5.1	27.25	138.975
7/25/15	12,843	2,319	0.21	5.1	25.88	131.988
4/25/15	12,137	2,437	0.21	5.1	28.83	147.033
1/24/15	11,936	2,397	0.19	5.1	29.51	150.501
10/25/14	12,245	1,828	0.19	5.1	27.64	140.964
7/26/14	12,357	2,247	0.19	5.1	24.99	127.449
4/26/14	11,545	2,181	0.19	5.1	24.62	125.562
1/25/14	11,155	1,429	0.17	5.3	21.8	115.54
10/26/13	12,085	1,996	0.17	5.4	21.25	114.75
7/27/13	12,417	2,270	0.17	5.4	23.31	125.874
4/27/13	12,216	2,478	0.17	5.3	24.12	127.836
1/26/13	12,098	3,143	0.14	5.3	20.86	110.558
10/27/12	11,876	2,092	0.14	5.3	18.91	100.223
7/28/12	11,690	1,917	0.08	5.3	19.08	101.124
4/28/12	11,588	2,165	0.08	5.4	16.33	88.182
1/28/12	11,527	2,182	0.06	5.4	19.88	107.352
10/29/11	11,256	1,777	0.06	5.4	18.64	100.656
7/30/11	11,195	1,232	0.06	5.5	15.67	86.185
4/30/11	10,866	1,807	0.06	5.5	16.8	92.4
1/29/11	10,407	1,521	0	5.5	18.56	102.08
10/30/10	10,750	1,930	0	5.6	19.16	107.296
7/31/10	10,836	1,935	0	5.7	19.99	113.943
5/1/10	10,368	2,192	0	5.7	23.16	132.012
1/23/10	9,815	1,853	0	5.7	24.33	138.681
10/24/09	9,021	1,787	0	5.8	23.4	135.72
7/25/09	8,535	1,081	0	5.8	21.6	125.28
4/25/09	8,162	1,348	0	5.8	18.5	107.3
1/24/09	9,089	1,504	0	5.8	14.57	84.506

 

What you should take away from the above table:

1. Revenue per quarter now ($12.3B over FY18) is identical to revenue per quarter in FY15 (also $12.3B).

commentary: Even with a paltry 2% inflation over 3 years that $12.3B should have grown to $13B.  On top of that, Cisco has acquired 25 companies over the last 3 years. That alone should add another $500M of revenue.  So at 0% real growth, Cisco revenue for FY18 should have been $13.5B, but it was not — only $12.3B — in real terms that’s a contraction of 9%.  Yuck!

commentary 2: In Q2 of FY18 Cisco actually reported a net loss of $8.8B — we took a one time charge associated with repatriating overseas capital for $11.1B.  I have not added in that $11.1B into the table above, otherwise the P/Es would be negative.

So based on #1 alone, Cisco’s stock price should have gone down 10% in the last 3 years, not up 82%.   Let’s move on…

 

2. Net Income per year is up slightly in three years, maybe. Take the above table and compute yearly numbers. Here are the year over year numbers for trailing 4 quarters net income:

FY18 has grown to $11.2B from FY15’s $9B (25%), but that’s not entirely accurate.  See the note about the Q2 charge. With that included, Cisco earned $0 for 2018.

So the company is not selling more, but it is making more money on the same volume of stuff sold. Good!  Let’s say that should increase the stock price, 10-20%.  So where do we get 82%?  Read on…

 

3. Shares are contracting.  The company continues to use profits to retire shares, going from about 6B shares a decade ago to under 5B shares now.  That is big. Same income spread across fewer shares yields higher EPS.  The reduction in shares from FY15 (5.1B to FY18 4.7B) is about 8%, so there is another 10% of that 82% we are looking for

 

4.  Multiple expansion. This is the real generator of wealth.  In FY15 Cisco had a P/E of 14.7 trailing (12.3 on a forward basis).  That was, just simply way too low.  Now we get a 19.8 trailing P/E and a forward estimate of about 18 — which is in line with the market. I personally think given the opportunity and space Cisco plays in we should get a rich premium over market multiples — not back to 2001’s 120x, but to 30x? Sure! The Internet of Things is a big opportunity and we are poised to capture it.

That expansion from 14.7 to 19.8 is 35% — so that’s 35% of the 82%.  Or is it?   Look more closely:

1.25 * 1.08 * 1.35 = 1.82

Did you see it? There is your 82%.

Increase earnings 25%

Decrease shares outstanding 8%

and expand the whole multiple 35%

— its a multiplicative effect — the net is 25% + 8% + 35% = 82% — it is geometric — the multiple applies not only to the new income, but to all income.  That’s the magic.

So in a real sense the Trump tax cuts are what has Cisco up 82% in 3 years. As the animal spirits come out and the multiples expand there is a real wealth effect generated.   Again, this is all in the backdrop of real revenue down 10% in 3 years.

How does the future set up?  Very well.  If the new revenues get to ~$14B per year, that’s 20% more than now. If the shares keep dwindling at a similar rate. that’s another 10%, and if the political backdrop remains the same and multiples continue to expand to 25 for Cisco — then that (1.2 * 1.1 * 1.25) = 65% — which would be $82.5 per share, which would tie the all-time high for the company set on 28 March 2000.