Stay bullish on Apple & Cisco

by Richard Moroney, editor Dow Theory Forecast

Apple (AAPL) shares have slipped nearly 10% since hitting an all-time high Sept. 21, when the iPhone 5 went on sale. Yet in some respects, Apple’s outlook has never looked brighter.

Meanwhile, Cisco (CSCO) has rebounded 26% from the July lows but remains attractively valued at just 10 times trailing earnings, more than 36% below its three-year average P/E and its peer-group median.

Despite problems with Apple's mapping application, the iPhone 5 has garnered favorable reviews and seen robust demand.

And new customers flock to the device — by one estimate, 70% of those buying an iPhone 5 this year have never before owned an iPhone. Researcher comScore expects Apple to expand its 17% share of the U.S. mobile-phone market this year.

Reports of component shortages, however, have tempered some expectations. Prices for certain semiconductors are spiking, suggesting a tight market.

Further complicating matters, Foxconn, a key supplier based in China, has experienced labor unrest at its factories in recent weeks.

The majority of initial iPhone 5 orders were likely delivered in September. But with demand still outstripping supply, shortages could persist throughout the December quarter.

The pullback leaves Apple shares trading at just 15 times trailing earnings, a 31% discount to the five-year average.

Should Apple’s P/E hold at 15 and the company meet the consensus profit estimate of $53.71 for fiscal 2013 ending September, the stock will rise 27% to $806 in the next 12 months. Apple is a Long-Term Buy.

Cisco Systems is by far the biggest player in the networking-equipment game. In this sector, size matters. In recent quarters, Cisco has used its size to great advantage, discounting products to grab market share from smaller rivals with less financial flexibility.

The company has cut costs and de-emphasized lower-margin businesses, focusing on its core routing and switching units to make more efficient use of revenue and fatten the bottom line.

Operating profit margins, pressured by economic weakness and restructuring from 2008 through 2010, are now trending higher, an impressive feat when you consider the price discounting.

Over the last 12 months, Cisco’s per-share profits rose 19%, while operating cash flow increased 14%. Sales growth, however, has been weak.

The 5% growth projected for the October and January quarters would represent the strongest in more than two years. Still, the consensus calls for profit growth of just 5% in the fiscal year ending July 2013 and 8% in fiscal 2014.

Warnings from other technology companies have cast a pall on the sector. However, analyst profit estimates have risen over the last 60 days but still understate Cisco’s growth potential. Cisco, yielding 3.0% after a 75% dividend hike in August, is a Long-Term Buy.

Learn more about this financial newsletter at Richard Moroney's Dow Theory Forecasts.

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• Cisco: Breaking out of the doldrums