Cisco Systems, Inc - is this its hour approaching?

Tech hasn't really performed this year, though it was one of many fund managers' top ideas for 2010. Just about the only interesting stock in the sector has been Apple (NASDAQ:AAPL), due to the excitement over iPhones and iPads.

But quietly, Cisco (NASDAQ:CSCO) has been doing rather well, though its shares haven't. Following a dreadful 2009 with earnings cut by a quarter, the company saw rapid recovery in quarterly earnings in Q1 and Q2 this year.

The key to Cisco is not individual products, but the fact that it can enable enterprise-wide collaboration across a number of end points and infrastructure products [ref] Goldman analysts quoted on Benzinga, http://www.benzinga.com/analyst-ratings/analyst-color/10/06/356394/goldman-sachs-reiterates-neutral-on-cisco-csco-rimm [/ref] . While its competitors have to use partnerships to provide total network solutions, Cisco can now offer a total solution using its own products (plus storage from EMC).

The move from simply offering routers to competing across the entire network is not without risk. Cisco used to work with companies like HP and IBM - now it's competing with them, notably in the server space, where it's also running up against Dell. The opportunity, of course, is immense, as cloud computing gathers pace (Cisco is working with VMWare to sell private clouds) and both storage requirements and data transmission amounts and speeds increase.

Cisco is already the leader in many of its markets. For instance in network security, with 35% of the market, it's streets ahead of Juniper and Check Point, which have only 10% each [ref] Forbes, 6 July 2010, http://blogs.forbes.com/greatspeculations/2010/07/06/mcafees-slice-of-the-cyber-protection-racket-can-get-the-stock-to-35/ [/ref] . And it has 70% of the ethernet switch market.

Across all its markets, it competes most directly with Juniper. There are other competitors across the range - Ciena for instance offers optical networks with a rather different architecture, and Avaya, which picked up Nortel's assets in a fire sale, is competing strongly in the market for unified communications systems. But I wouldn't bet on anyone managing to dethrone Cisco this time round - its lead is simply too great. The major networking markets have recovered well from the 2009 lows - industry analyst Infonetics says the Ethernet switch market saw a 23% sequential increase in revenues in the first quarter of the year [ref] The Street, 15 June 2010, http://www.thestreet.com/story/10784201/1/cisco-switch-sales-booming.html?puc=tscmarketwatch&cm_ven=tscmarketwatch [/ref] . And Cisco is certainly getting its share of this growth - in fact, possibly more than its share, as it has been regaining market share in carrier ethernet.

That's what makes me interested in Cisco shares right now.... Not the Cisco Cius - whether or not it can compete with the iPad, its real importance is simply adding another end device to Cisco's total network capability. And not the move into optical technology with the purchase of CoreOptics, though this makes Cisco a far better competitor against network rival Ciena. Cisco is one of those stocks where it's difficult to see the wood for the trees, but I think the trees are growing pretty fast now. It's the core networking, where Cisco has strong credentials and massive growth opportunity, that is the basis of value.

According to one analyst, network upgrades are now building momentum [ref] Barrons, 21 June 2010, http://blogs.barrons.com/techtraderdaily/2010/06/21/cisco-pacific-crest-repeats-buy-rating-lifts-target-estimates/ [/ref] . I suspect networking will do better than software over the next few years; first of all, companies are tired of the software upgrade cycle and want a rest (not least from having to retrain staff on new versions of Windows), and secondly, increased traffic levels are forcing infrastructure spend (while there's no business case for increased spend focused at revenue generation).

Two other factors catch my attention. First, Cisco is moving rapidly into emerging markets India and Russia. The eye remains firmly on the ball for the long term (which you couldn't say about all the companies in this space, some of which are in financial disarray and focused on cost cutting rather than the longer term future). Secondly, it has well over USD 20m of net cash sitting on the balance sheet (but still doesn't pay a dividend). Deep pockets.

So if I'm right about the appeal of the company, it should surely be sitting on a premium PER, like Juniper, which trades at 48x projected earnings. Right?

Er, nope. Cisco right now is on about 14x projected earnings. True, it's not growing as fast as Juniper (NYSE:JNPR), which should see 25% CAGR over the next few years, but a 12-18% growth rate is pretty decent, and doesn't really seem to be rewarded by the PER. Even Hewlett Packard (NYSE:HPQ), which is likely to see a much lower growth rate (10%, pretty pedestrian for a tech stock), is rated at 12.9x earnings, so Cisco doesn't have much premium over the dog of the sector.

Goldman has a neutral recommendation on the stock, but I've noticed quite a few other brokers putting it on the buy list with a USD 30 target price or above.

If only it paid a dividend...