Profitable Connections
In this edition of the Smart Investor newsletter, we examine the stock of the world’s largest networking and communications infrastructure provider. But first, let’s dive into the latest Portfolio news and updates.
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Portfolio Updates
❖ Broadcom (AVGO) saw its stock surge to an all-time high and its market cap cross a $1 trillion threshold, putting the company on track to join the members of the “Magnificent” pack. AVGO posted better-than-expected quarterly and annual results and projected strong demand for its AI offerings going forward.
In its fiscal year 2024 (ended on November 3rd), Broadcom reported a year-over-year top-line increase of 44%, driven mainly by an 181% jump in its AI-related infrastructure software segment’s revenue which soared on the successful integration of VMware. Although semiconductor solutions’ revenue rose by a modest 7% in FY24, it reached a record thanks to surging sales in AVGO’s custom AI accelerators and networking segment. Broadcom’s total AI-related revenue soared by 220% year-over-year, driven by AVGO’s AI XPUs and Ethernet networking portfolio.
Broadcom issued an optimistic outlook, expecting its AI accelerator business to drive growth over the next three years. In addition, the company said it expects the non-AI semiconductor business to recover in 2025 after bottoming out this year, adding to revenue growth. Following the strong financial performance, Broadcom raised its dividend by 11%. Wall Street analysts rushed to upgrade the chip giant’s price targets, but the soaring stock has already outpaced these newly minted optimistic outlooks.
❖ Arista Networks (ANET) was another notable outperformer. The networking equipment and software provider’s stock climbed to an all-time high after a slate of Wall Street analysts upped their price targets on the stock, saying that the boom in AI infrastructure demand will benefit the cloud networking solutions provider. The company’s stock was also supported by a recent 4-for-1 stock split.
❖ Amazon (AMZN) also saw a slate of price-target and rating upgrades, with analysts praising its cloud market dominance and significant improvements in its AI offerings, supporting the outlook for continued acceleration in revenue growth. Analysts expect continued margin expansion, driven primarily by the scaling of the high-margin AWS and Advertising segments, and are forecasting even stronger AWS revenue growth going forward.
❖ Microsoft (MSFT) and Alphabet (GOOGL) may be designated by the U.S. Department of Commerce to act as global gatekeepers for access to AI chips, according to a Reuters report. Under this arrangement, the tech leaders will comply with strict requirements, which include thorough reporting and restricting Chinese entities’ access to cutting-edge semis.
❖ Microsoft (MSFT)-backed OpenAI announced the expansion of its ChatGPT Search to free users, with an option to set up ChatGPT as a default search engine in web browsers. In an apparent escalation of the AI search arms race, this move signifies OpenAI’s increasing push to capture market share, creating a distant, but real risk for Google’s long-standing search engine monopoly.
❖ Alphabet (GOOGL) continued its surge, surpassing its previous all-time high reached in July. The tech leader’s stock outperformance, sparked a week ago by its quantum computing breakthrough, was further supported by several pieces of positive news that underscored its leading role in technological innovation.
For starters, Alphabet’s Google division unveiled Gemini 2.0, the second generation of its AI model, and highlighted new AI applications, including AI features for eyeglasses and smartphone cameras. CEO Sundar Pichai described this as the beginning of a “new agentic era,” where virtual assistants act with more autonomy under user supervision. Google aims to leverage its massive user base across Search, Android, and YouTube to regain leadership in AI, competing with OpenAI’s recent advancements.
In addition, Google introduced two advanced generative AI models: Veo 2 and Imagen 3, each enhancing capabilities in video and image generation, respectively. Veo 2 is Google’s latest AI video generation model, building upon its predecessor to deliver high-quality, realistic videos. Meanwhile, Imagen 3 is Google’s AI image generation model, designed to produce high-quality, photorealistic images from text prompts. Google’s creative tools suite also offers Imagen 3-powered Whisk, an AI tool that allows users to create and remix images. The company’s rollout of AI-based creative tools is seen as a significant advancement, which could enhance user engagement and revenue growth.
Another positive news arrived from the political spheres, where President-elect Trump’s appointment of Andrew Ferguson as FTC chair is seen as beneficent for Big Tech, including Alphabet.
❖ Waymo – the autonomous robotaxi unit of Alphabet (GOOGL) – announced it would perform a test of its fleet in Japan in early 2025. This would be Waymo’s first international destination, seen as a first step in its potential geographical expansion beyond the U.S. In more good news for Waymo, one of its biggest potential competitors in the U.S., GM’s autonomous driving unit Cruise, is shutting down due to mounting losses and company-specific challenges.
❖ Uber Technologies (UBER) saw its stock tentatively regain some ground from the previous week’s slump, which was caused by news about Waymo’s expansion to Miami without the help of the ride-hailing leader. Several leading Wall Street analysts expressed positive opinions on the company, confirming or assigning “Buy” ratings with optimistic price targets. The average analyst price target now implies an upside of over 55% for Uber’s stock over the next 12 months. Goldman Sachs has recently called Uber its top pick for 2025 among its Large Cap coverage.
According to analysts from Jeffries, BofA, JMP Securities, Goldman Sachs, and others, the company’s rapid expansion in both its ride-sharing and delivery services sectors, supported by its continuous innovation and the development of new products, is poised to further accelerate business momentum. Moreover, Uber’s strategy of expanding services and forming delivery partnerships, as well as its entry into new markets, is anticipated to significantly boost revenue growth. In addition, analysts anticipate increased collaborations between Uber and AV developers, since providing services through Uber’s existing all-in-one ride marketplace is significantly more economically sensible for AV suppliers than building their own networks.
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Portfolio Stocks Under Review
❖ We are placing Arch Capital Group (ACGL) under review for a possible sale. Although there were no apparent company-specific negatives following its slight EPS miss on Q3 2024’s EPS, the stock seems to experience a strong downward momentum. In addition, there are some pressures on the larger insurance-stock universe. We believe that the negative momentum is largely due to profit taking following ACGL’s strong run this year through mid-October, when it reached an all-time high. Analysts from leading Wall Street firms rate Arch Capital a “Buy” with an average price target implying an upside of over 33% in the next 12 months. However, we plan to watch the developments closely, ready to sell if there is a hint of trouble.
❖ We are placing GE Aerospace (GE) under review for a possible sale. One of the Smart Portfolio’s longest-held stocks, it had been our star performer until mid-October, when it reached an all-time high. Since then, the stock has been under pressure, both from the general Industrial sector underperformance, and from company-specific issues. Investors became anxious that GE shares may have outrun their fundamentals, specifically in light of ongoing supply chain issues and decreased revenue growth in its commercial engines and services segment.
In addition, in early December, Safran – GE Aerospace’s partner in the CFM International joint venture – provided a preliminary 2025 outlook that fell short of market expectations, contributing to pressure on GE stock. Analysts from leading Wall Street firms rate GE Aerospace a “Strong Buy” with an average price target implying an upside of over 27% in the next 12 months. However, we will follow the company news closely and sell the stock if its momentum doesn’t turn for the better.
❖ We are placing Abbott Laboratories (ABT) under review for a possible sale. Despite its diversification, strong and expanding portfolio, leading market position, and enviable finances, the company has experienced a selling pressure.
Abbott’s shares are seen as richly valued, which limits their near-term upside, especially in light of the many uncertainties for the firm – and the broad Health Care sector – in the near future following Trump’s reelection. On the one hand, a move towards deregulation may streamline approval processes for medical devices and diagnostics, areas where Abbott Laboratories has substantial operations. This could facilitate quicker time-to-market for new products, enhancing competitiveness. However, increased market competition is a double-edged sword, as ABT would need to maintain or even accelerate innovation and cost-effectiveness to stay ahead. Moreover, there is bipartisan support for addressing high drug prices. If drug pricing reforms are implemented, Abbott’s pharmaceutical segment might experience pricing pressures.
We believe that Abbott Laboratories is well-positioned to adapt to a more flexible regulatory environment, and to implement policies to mitigate potential impacts from drug-pricing reforms. However, taking into account ABT’s vulnerability to market sentiment swings stemming from its high valuation, we will watch it closely before deciding whether to retain it in the Portfolio.
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Portfolio Earnings and Dividend Calendar
❖ The Q3 2024 earnings season is over, and no Smart Portfolio companies are scheduled to release their quarterly results until mid-January.
❖ The ex-dividend date for Broadcom (AVGO) is December 23rd.
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New Buy: Cisco Systems (CSCO)
Cisco Systems, Inc. is an American multinational technology conglomerate headquartered in San Jose, California. It designs, manufactures, and sells networking hardware, telecommunications equipment, software, and technology services. CSCO is the largest networking and communications infrastructure provider in the world (outside of China) and dominates the global market for networking hardware. In addition, it holds a leading share in enterprise networking equipment globally.
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Building the Internet’s Backbone
Founded in 1984 by two Stanford computer scientists, Cisco Systems pioneered computer networking and played a critical role in shaping internet communications. Cisco revolutionized networking by developing the multiprotocol router, enabling communication between different networks, and driving the adoption of Internet Protocol (IP) as the universal standard for the modern Internet.
Cisco developed advanced switches that transformed enterprise LANs, led the commercialization of VoIP technology, and pioneered network security solutions such as firewalls. Its Unified Communications and Software-Defined Networking (SDN) systems revolutionized business communications and network automation. The company popularized VPN technologies for secure remote access, was at the forefront of enterprise Wi-Fi networks, and introduced high-definition video conferencing and telepresence long before tools like Zoom became mainstream.
Over the years, Cisco has maintained its leadership through continual innovation, in-house development, and strategic acquisitions. It remains a leader in IoT networking, enabling smart cities and industrial IoT systems, and has integrated AI and Machine Learning (ML) across its portfolio. AI enhances Cisco’s Intent-Based Networking systems, cybersecurity products, and collaboration tools like Webex, while also optimizing data center solutions such as Intersight, UCS, and Nexus Dashboard.
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AI-Ready Business Model
CSCO has steadily expanded its market capitalization since its nadir in the aftermath of the Dot-Com bubble’s bust. The company boasts a market cap of $232.4 billion and annual revenues of ~$57 billion, positioning it among the top 20 largest technology companies in the world. Moreover, in the 2024 Fortune 500 list, Cisco advanced eight positions to #65, reflecting its robust performance.
However, the company never rested on its laurels, consistently adapting to the evolving technology landscape. Since the mid-2010s, the company has diversified beyond traditional hardware, transitioning towards subscription-based models, software, and recurring revenue streams. This strategic shift has enabled Cisco to maintain profitability, even during periods of slowed global telecommunications equipment spending.
While demand for Cisco hardware in the telecom and cable sectors has experienced fluctuations due to industry cycles, the company’s expansion into AI and software solutions has mitigated the impact of these downturns. The increasing adoption of AI across various industries positions Cisco to capitalize on AI-related revenue growth, leveraging its expertise in network infrastructure and AI integration.
Cisco continues to invest in AI infrastructure, particularly for hybrid cloud environments. Recent acquisitions, including Splunk for AI-driven analytics, Armorblox for AI cybersecurity, and Lightspin for cloud-native solutions, reflect its AI-driven growth strategy. Partnerships, such as its collaboration with Nvidia, further position Cisco at the forefront of technological advancements.
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Gearing Up With Nvidia
The global AI infrastructure market is projected to grow at a CAGR of 30.4% from 2024 to 2030, reaching approximately $107 billion by 2028. Concurrently, investments in AI infrastructure are expected to drive data center capital expenditures to over $500 billion by 2027, highlighting the growing demand for data center components and networking solutions.
Major cloud providers, such as Microsoft, Alphabet, and Amazon, are rapidly increasing spending on servers and infrastructure to power their AI products and services. For instance, Microsoft reported $15 billion in capital expenditures for the latest quarter, marking a 50%+ year-over-year surge, primarily driven by investments in AI infrastructure and data centers.
This surge in AI and cloud-related capex creates significant opportunities for “picks and shovels” providers like Cisco, whose essential networking hardware and solutions underpin AI capabilities. Cisco has expanded its data center infrastructure portfolio with AI-ready server solutions, including a family of servers purpose-built for GPU-intensive AI workloads powered by Nvidia accelerated computing. Additionally, Cisco introduced AI PODs (Performance-Optimized Data Centers), pre-integrated systems designed to simplify and de-risk AI infrastructure investments, offering organizations scalable and adaptable pathways to AI adoption.
Collaborations with industry leaders like Nvidia enable Cisco to deliver comprehensive AI infrastructure solutions that address the escalating demands of enterprises and cloud providers. This partnership enhances Cisco’s ability to deliver the massive computing power required for training and inference workloads in AI applications.
Cisco’s strategic shift toward AI-driven solutions aligns with growing demand for AI-ready infrastructure. This is reflected in Cisco’s increased annual revenue forecasts, signaling confidence in its position within this expanding market. With its robust suite of AI-optimized networking solutions and strategic partnerships, Cisco is well-positioned to capitalize on the AI infrastructure boom, potentially driving accelerated revenue growth in the coming years.
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Fundamentally Superior
Despite numerous acquisitions – ten companies in the past two years alone – Cisco maintains strong financial health, supported by a modest net debt-to-equity ratio and a significant cash reserve that ensures ample liquidity. The company’s balance sheet strength is further reflected in its high credit ratings: “AA-” from S&P and “A1” from Moody’s.
CSCO remains a leader in capital efficiency and profitability metrics. Its ROA is among the best performers in the Hardware industry, while its Return on Equity ROE ranks within the industry’s top tier. Additionally, Cisco’s gross, operating, free cash flow, and net profit margins place it among the most profitable companies in its sector.
The only area where Cisco has lagged its peers in recent years is revenue and EPS growth. These metrics have faced pressure due to global economic uncertainties and reduced spending on networking infrastructure. Tough year-over-year comparisons, following the post-pandemic surge in demand, have further amplified this challenge. As a result, revenues and EPS experienced declines in fiscal 2024 and the first quarter of fiscal 2025. However, CSCO’s reported results still exceeded analyst projections, continuing a trend of outperformance since at least 2021.
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“Old Tech” To The Fore
Cisco is focusing on long-term growth drivers, strategically investing in acquisitions and in-house innovations. Its recent acquisitions align with high-growth markets, such as AI, cloud infrastructure, and cybersecurity, and are aimed at expanding its software and subscription-based services, key areas for sustained long-term growth.
At the same time, Cisco is making significant investments in AI-driven solutions. These include Intent-Based Networking, AI-optimized data center offerings, and advanced security platforms. Cisco’s introduction of AI PODs and its partnerships with Nvidia allow it to capitalize on rising demand for AI infrastructure.
Moreover, Cisco’s transition from hardware-centric sales to subscription-based revenue models enhances financial stability and predictability. Subscription-based revenue now accounts for more than half of Cisco’s total, signaling the success of its strategic pivot.
As a result, the company is turning the corner in terms of growth, expecting to see an annual revenue increase already in this fiscal year. CSCO has raised its revenue outlook for fiscal Q2 and full-year 2025, citing accelerating demand for AI-powered networking solutions and reflecting confidence in its growth strategy. The company’s leadership confirmed that corporate spending on AI infrastructure is increasingly benefiting Cisco’s business.
Furthermore, the ongoing integration of Splunk and other acquired companies is expected to strengthen Cisco’s software and cybersecurity offerings, further supporting growth. CSCO’s diversification into high-margin software solutions is already showing results, reflected in its two-decade-high gross margin, a surge in operating cash flows, and significant year-over-year growth in software revenue.
Finally, Cisco’s growing Annualized Recurring Revenue (ARR) and increasing share of subscription-based income underscore its successful transformation into a more resilient, software-driven business. These strategic efforts position Cisco to capitalize on emerging opportunities and accelerate its long-term growth trajectory.
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Still Attractively Priced, Given the Fundamentals
Cisco Systems’ stock has risen by approximately 17% over the past year, with most gains materializing in the second half of 2024, driven by the company’s upbeat forecasts in recent quarters. Despite a nearly 30% jump from its recent low in early August, CSCO remains attractively valued, trading at a ~30% discount to the Technology sector’s average and near the bottom of the valuation range compared to its industry peers. Additionally, based on projected cash flows, the stock appears undervalued by about 20%.
When considering Cisco’s total return potential, it’s important to highlight the company’s strong focus on shareholder compensation through dividends and share buybacks. Cisco’s solid fundamentals enable it to balance capital returns with investments in long-term business growth. Cisco has been paying and increasing dividends since 2011. While the pace of dividend increases has been moderate in recent years, its current dividend yield of 2.71% remains notably high – more than four times the average yield for the Technology sector.
Furthermore, Cisco has maintained an active share repurchase program since 2022. The company currently has $3.2 billion remaining under its existing authorization, with no termination date. Cisco has been aggressive in its buyback activity, having repurchased $6.1 billion worth of common stock in fiscal 2024 and adding another $2 billion in buybacks in the first quarter of fiscal 2025.
Cisco’s recent optimism about its return to growth, combined with consistent buybacks that support share price appreciation, has led analysts from leading Wall Street firms to revise their price targets upwards. While the current average price target implies an upside of approximately 8% over the next 12 months, this figure reflects an ongoing re-rating process. Notably, Morgan Stanley raised its price target on December 17th, citing strong financial performance, strategic acquisitions, AI-driven demand, strong market position, and attractive valuation.
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Investing Takeaway
Cisco Systems, Inc. is a global leader in networking and communications infrastructure, strategically transitioning toward AI-driven solutions, software, and subscription-based services. Cisco’s robust financial health, marked by strong profitability, exceptional cash flows, and modest debt, underpins its shareholder-friendly approach through dividends and share buybacks. Recent acquisitions bolster its capabilities in cybersecurity and AI analytics, while partnerships with industry leaders like Nvidia position Cisco to capitalize on the booming demand for AI infrastructure. The company’s shift to recurring revenue models enhances financial predictability, with over half of its revenue now subscription-based. Combined with attractive valuation metrics, ongoing innovation, and increasing AI-related demand, Cisco is well-positioned for accelerated revenue growth and long-term value creation. We view CSCO as an attractive investment for the Smart Investor Portfolio.
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New Sell: Adobe (ADBE)
Adobe Inc. is an American multinational software company headquartered in San Jose, California. The company, incorporated in 1982, has historically specialized in software for the creation and publication of various types of content, including graphics, photography, animation, documents, and many more. Adobe is widely known around the globe for its flagship products, such as Photoshop, Illustrator, Dreamweaver, Acrobat Reader, PDF document format, and Flash multimedia platform, among others. In recent years, the company has expanded into a subscription software-as-a-service (SaaS) niche with its Adobe Creative Cloud product suite, as well as into the digital marketing software area.
Adobe is one of the largest and most profitable software firms in the world, with rock-solid balance sheet, enormous cash pile, impressive margins, and consistent revenue growth. On December 11th, the creative giant produced another set of strong quarterly results, including YoY revenue growth of 11% and EPS growth of 12.7% in it5s fiscal Q4 2024. However, exceeding analyst projections wasn’t enough to lift ADBE’s stock, which sunk after the company provided underwhelming revenue and EPS guidance for fiscal 2025.
The emergence of AI-driven creative tools from companies like OpenAI and Google has intensified competition in the digital media space. Adobe’s substantial investments in AI technologies, such as its Firefly generative AI toolset, have yet to demonstrate clear monetization strategies, contributing to investor anxiety.
While acknowledging Adobe’s strong Q4 performance, analysts also have expressed concerns. Although ADBE is rated as a “Buy,” several analysts adjusted their price targets downwards, citing the absence of visible earnings-growth catalysts in the near term due to Adobe’s strategy of increasing its free user base before leaning into monetization. While this approach worked well with Adobe’s PDF and other tools, the stiffening competition in the Creative AI space may disrupt this monetization funnel.
We believe that longer term, Adobe is well-positioned to regain leadership and plan to revisit the stock when we observe positive developments in terms of AI monetization and market-share protection. However, for now, we believe it is prudent to sell the stock.
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Smart Investor’s Winners Club
The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
Despite the volatility in the markets in the past few days, our exclusive club’s ranks remained unchanged except for the movements within the Winners’ cohort, still including 16 stocks: AVGO, ANET, GE, EME, TSM, ORCL, TPL, HWM, APH, PH, ITT, IBKR, PYPL, PNR, CRM, and KKR.
The first contender is still AMZN with 28.74% gain since we purchased it on September 11th. Will it close the gap, or will another stock outrun it to the finish line?
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Disclaimer
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