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Buy Cisco, Cheapest Tech Stock on the Market, and Short Riverbed

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My emotional attachment to networking giant Cisco (CSCO) is now widely known -- to the extent that recently it has been suggested that I have become the company's unabashed cheerleader. Be that as it may, what is absent in my new label and, disappointingly, what continues to be ignored on Wall Street are the fundamental reasons for this connection. The fact of the matter is, I look at rivals such as F5 (FFIV) and Juniper (JNPR) trading at multiples respectively three and 2.5 times that of Cisco's P/E of 12 and wonder: What is this market thinking?

From a fundamental perspective (and likely a great source of my attachment) is the fact that the company is sitting on $32.04 billion of net cash, less debt, while trading at roughly nine times earnings, excluding net cash. It is also remarkable to appreciate that not only has Cisco provided double-digit returns on capital but, as noted recently, is a dominant player in its industry -- one poised to grow at a faster rate than the economy. But the stock is down 12% since reporting earnings May 9, and I think the market continues to overlook what has become the cheapest tech stock on the market.

There wasn't anything in the report to justify the punishment endured by the stock over the past several days. As a matter of fact, Cisco beat estimates on the top and bottom lines. It reported earnings of $0.48 per share on revenues of $11.6 billion. By comparison, one of its rivals, Riverbed (RVBD), recently reported earnings that missed on both top and bottom lines. However remarkably, its stock still enjoys a multiple of 50 or four times that of Cisco's while trading $0.49. This is even more justification for why I have recently considered Riverbed one of the most expensive equities on the market and a likely short to $15.

It is clear Cisco is moving in the right direction, although investors wish to remains skeptical. This is not a huge surprise, but it begs the question: How efficient is this market really when there continues to be such a significant disparity between the performances of two rivals where one (Cisco) clearly outperforms, but the other (Riverbed) is held in higher regard? What are investors missing? Understandably, at one point Wall Street had to deal with the fact that the company made some poor decisions and took its eye off the ball for several quarters, a period resulting in some lost market share to, among others, Hewlett-Packard (HPQ) and Dell (DELL). But Cisco's recent report served to alleviate concerns regarding the company's ability to execute in the face of shrinking corporate enterprise budgets.

For as bad as things once appeared, it continues to be a major challenge to not value Cisco by any measure. The reality is that its equipment still powers more than half the Internet. In disappointing fashion, though, investors opted to overreact and bail on the stock based solely on the company's guidance. Management said fourth-quarter earnings expectations were going to arrive in the range of $0.44 to $0.46 per share on revenue growth of 2.5% -- slightly below analysts' projections of $0.49 per share and 7% growth in revenue. Without a doubt management has taken the right approach and investors will just have to be patient with how things unfold, particularly with the company's high exposure to Europe and its well-documented fiscal challenges.

Bottom line
There is no doubt that buying on weakness is the best play for investors at current levels. As noted, not only is the stock down 12% since reporting its third-quarter announcement, but it is off 22.5% since reaching its 52-week high of $21.30 reached just one month ago. The company is executing as well as any other company on the market and investors will be rewarded with higher share gains generated from improving margins. Cisco's turnaround story has just begun, and its extremely low valuation relative to its future data demand potential makes it the cheapest tech stock on the market, while Riverbed remains grossly expensive.
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