I own a lot of Cisco shares through my investment in the Steadyhand Equity Fund and Global Equity Fund.  It’s a stock that appears in more than one of our funds. 

I just went through the company’s February 4th investor presentation and not surprisingly it reported a profit decline of 16% in its second quarter (US$0.26 per share versus $0.33 last year).  I am not a stock analyst any more, and certainly not a technology expert, but Cisco provides a striking example of what we’ve been talking about in recent months – in this economic environment, the strong will get stronger.

Everyone’s earnings are down (and in some cases they’ve disappeared), but companies that have strong cash flows and liquid balance sheets are in a different league when it comes to weathering the storm.  Consider the following:  Cisco’s revenues dropped 7.5% in the quarter, but it still generated $3 billion in cash flow.  As the credit crisis dragged on, finance subsidiary Cisco Capital continued to finance its customers.  And instead of distressed asset sales and dilutive equity or debt issues, the company bought back $600 million worth of stock in the quarter. 

If I’m sitting at CEO John Chambers’ desk, I’d be jumping out of my skin with excitement.  His company hasn’t needed much help carving up the competition, but he’s probably never seen a time when Cisco was in a better competitive position.

And yet, with the stock down 50% from its 2007 high, the market is now putting a lower multiple on future earnings and cash flow.  Certainly, the price had to come down to reflect the current circumstances (i.e. reduced 2009 and 2010 earnings), but most of Cisco’s value comes from expected earnings well beyond that time frame.  It’s not unreasonable to expect that that earnings stream will be better than we previously expected (i.e. less competition and fewer shares outstanding) and deserving of a higher multiple. 

In the meantime, I don’t expect that Mr. Chambers is grumbling about his stock price too much, and neither should we.  Mr. Market has given him, and investors like us, a great opportunity to enhance our future profitability by buying a better future at a lower price.