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Stock Strategist

Two Tech Stocks Trading at a Rare Value

These solid firms in tech have gone on sale.

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With the stock market in turmoil,  Cisco (CSCO) and  Juniper (JNPR) have again fallen below our Consider Buying price. Although we can understand investors' reluctance to jump feet first into equities at this point, we believe both of these firms' long-term prospects remain intact.

Both companies fell victim to the collapse of the technology bubble earlier this decade. From August 2000 to March 2001, each stock lost 80% of its market value, and both remain well below the peak in 2000. Although it's clear that investors overestimated the amount of value that these two networking firms would capture as people around the world plugged into the Internet, both firms have steadily grown during the last eight years. We're now in another period of high uncertainty, and with the U.S. economy on shaky ground and non-U.S. markets losing steam, corporate IT budgets will likely be cut. Despite this short-term murkiness--which has pushed both Cisco and Juniper shares sharply lower thus far in 2008--we think investors will be handsomely rewarded by owning these stocks over the long haul.

Three Reasons Why Cisco and Juniper Are Great Buys
Our investment thesis on both firms rests on three points. First--and most important in the short run--both companies are flush with cash. Cisco has more than $20 billion in net cash, while Juniper has more than $2 billion. Cisco has already generated nearly $6 billion in free cash flow since the beginning of the year. Although Juniper's $375 million in free cash flow pales in comparison to its larger rival, that number is still impressive considering Juniper has generated all of that cash on less than $2 billion in revenue. While recent performance has been solid, history suggests that both companies will navigate a downturn reasonably well. During 2001 and 2002, when earlier years of overinvestment combined with recessionary pressures led to a precipitous decline in corporate IT spending, Cisco managed to generate more than $8 billion in free cash flow, while a much smaller Juniper eked out $18 million.

Looking longer term, the underlying fundamentals for these businesses also remain healthy. Both firms are key enablers of global interconnectivity--that is, helping people communicate anywhere in the world. We think that the trends of mobility, network convergence, and global connectivity will ensure that the markets for these firms' primary products will grow over the long run. Cisco and Juniper are market leaders, and we expect both firms to take share from weaker competitors.

Finally, unlike the heady market capitalizations enjoyed by Cisco and Juniper prior to the tech bubble collapse earlier this decade, each of these companies is trading at a reasonable valuation today. Our discounted cash-flow models bear this out, but so does a quick gut check. Subtracting each firm's net cash balance from its market capitalization, Cisco is trading at roughly 10 times the amount of cash it generated in the previous 12 months, and Juniper is trading at roughly 12 times its trailing 12-month free cash flow. Although not dirt cheap, we think these are very modest valuations given the strength of the underlying businesses.

Each firm's stock price could certainly fall further in the near term, but it's not often that investors can buy such great businesses at such reasonable prices, in our view. These are two of a number of firms within the technology sector that have become attractively priced, and now is a good time to be choosy. Particularly in the current market environment, we would look to invest in firms trading at a reasonable discount to our fair value estimate that have narrow or wide moats, healthy balance sheets, and generate plenty of cash. We think investors with longer time horizons will do very well by sticking with this strategy.

Grady Burkett does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.