Does Cisco Capitalize on Beating Analysts’ Earnings Estimates? Is it a Buy?

Cisco Systems (CSCO), over the previous three years, has beaten analysts’ earnings estimates 12 consecutive times. Its price movement in this timeframe has been, quite literally, a rollercoaster.

Source: E*TRADE

As we can see in the graph above, CSCO’s stock price has, despite continuously favorable performance relative to analysts’ forecasts, not been able to fully capitalize with respect to pricing.

The inability to retain this positive price movement then becomes a question of interest to investors. As of December 19, 2023 CSCO ranks 295th in returns on the S&P 500 in the past year. It leads us to wonder why CSCO has not been able to capitalize on its earnings streaks as market literature tells us it should.?

Or has it?

Market literature tells us that:

1. Stocks that beat analysts’ earnings estimates deliver greater returns in the ensuing quarter than stocks with similar predictions that fall short of analysts’ estimates (Bartov et al.)
2. Stocks with consecutive earnings surprises (beating analysts’ estimates) deliver excess returns (Loh and Warachka)

The stock’s price seems to have changed little in that interval, being priced at $48.08 on February 5th, 2021 and $50.24 at the close on December 18, 2023. That is a gain of 4.49%.

The S&P 500 meanwhile, has risen 21.97% from 3887 to 4741 in that same timeframe.?

But, perhaps our expectations for growth are merely too high. After all, what kind of growth does market literature project for 12 consecutive quarters of beating analysts’ estimates?

The answer to that question is available in the chart below.?

Source: Management Science, Vol. 58, No. 7, pp. 1305-1321, pg. 1313.

In the top of this chart, we identify the range of returns for stocks with earnings surprises streaks of 10 or more. This is adjusted by the SURP quintile, where SURP is past earnings surprise, and stocks are assigned to these quintiles each month.?

Among stocks with earnings surprise streaks of 10 quarters or more, the lowest SURP in the preceding month returned an average of -0.67% in the following month. Stocks with the highest SURP returned an average of 0.45% in the following month.?

In the past year, beginning December 18, 2022 CSCO closed at $47.48, and ending December 18, 2023 CSCO closed at $50.05. That is a gain of 5.41%, or 0.45% per month. If only considering the past year, that would put CSCO between the third and fourth quintiles, indicating that CSCO performed as if it were a stock with an above average earnings surprise in the previous quarter.

If we go back three years, CSCO closed at $45.44 on December 18, 2023. That 10.15% return over 36 months equates to a 0.28% gain per month, once again between the third and fourth quintiles. This classifies CSCO with stocks having an average-to-above-average earnings surprise.

CSCO, with 12 consecutive quarters of beating analyst estimates, has gained about 18% in the previous five years, though it is down about 12% and 20% from its high points of $57.58 on July 12, 2019 and $63.96 on December 29, 2021, respectively.

So, now it appears we can answer the question ‘Does Cisco Capitalize on Beating Analysts’ Earnings Estimates?’ The answer is yes.

But is CSCO a buy?

The answer to this might be no. According to E*TRADE, an 18-analyst consensus on CSCO's next earnings per share announcement is a steep, 24% decline, to $0.84 per share. In addition to this, the consensus among 16 analysts is that CSCO will experience a 13% drop in revenue in the ensuing quarter.

It is unlikely to be the case that CSCO will experience an increase in price after significant declines in earnings-per-share and total revenue. Indeed, the decline in revenue is partly responsible for the market’s expectations of a decline in CSCO’s EPS.

There are two final pieces of information that may tie this all together.

The first is the 61% decline in cash flow-per-share between the earnings announcement on August 16, 2023 ($1.46 per share) and November 15, 2023 ($0.58 per share). Investor response was swift, resulting in a fall from $53.28 at closing on November 15, 2023 to $48.04 at the close on November 16, 2023. This was a decline of about 9.8%.

The second piece of evidence is the decline in CSCO’s price-to-earnings ratio over the past two years. Where price-to-earnings indicates the price-per-dollar that investors are willing to pay for a stock’s earnings, CSCO’s price-to-earnings ratio has fallen roughly 33%, from 18 to 14.

CSCO has been able to increase in share price over the past five years, likely as a result of beating analysts’ earnings expectations, though it has not been able to maintain its gains and stands to decline in the first quarter of 2024.?

For these reasons, it does not appear that CSCO is a buy.

References

Eli Bartov, Dan Givoly, and Carla Hayn, 2002. “The rewards to meeting or beating earnings expectations.” Journal of Accounting and Economics, Vol. 33, Issue 2, pp. 173-204.

Roger K. Loh and Mitch Warachka, 2012. “Streaks in Earnings Surprises and the Cross-Section of Stock Returns.” Management Science, Vol. 58, No. 7, pp. 1305-1321.

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