Why we’re buying more Cisco – Bristlecone Value Partners (CSCO, MOT, TYC, HD, AXP, INTC)

Author: Bristlecone Value Partners, LLC
Covestor Model: Large Cap Value
Disclosure: Long CX, MOT, TYC, HD, WPO, AXP, INTC, CSCO

Dear Fellow Investors,

During December, the S&P 500 gained 6.53%* on the back of renewed optimism in the economic recovery. The gains were pretty widespread as all sectors saw positive returns with Materials, Telecom, and Consumer Discretionary leading the way. Our portfolio outperformed the index as it rose slightly above 8% during the same period. The portfolio’s top five gainers in December were: Cemex (+18.5%), Motorola (+18.4%), Tyco Electronics (+16.9%), Home Depot (16.9%), and Washington Post (+16.6%). Only 2 stocks lost ground: American Express (-0.7%), and Intel (-0.6%).

As we start a new year, it is also a good time to review the portfolio’s performance in 2010. From inception on July 12th through the end of the year, the portfolio slightly underperformed the S&P 500. This relative under-performance was driven mostly by negative contributions from Cisco, NRG, EOG, Apollo, and Sprint over the period. Yet, we remain confident that each of these investments has the potential for significant appreciation in the next 2 to 3 years.

Earlier in December, we disposed of our remaining shares of Waste Management (WM) as the stock reached our assessment of the company’s intrinsic value. It was time to move on, and look for opportunities at greater price-to-value discounts.

We used the capital to add to our investment in Cisco Systems (CSCO), taking advantage of the recent stock price weakness following some cautious guidance from management. We feel that this company embodies what we typically look for in an investment: a durable competitive advantage (economies of scale and high customer switching costs), a strong balance sheet, competent management, and a stock price at a significant discount to our assessment of the value of the company. Frankly, we do not expect Cisco to grow in the future at a rate anywhere close to what it has achieved in the past. However, we expect the company to maintain its market share in data networking for the foreseeable future, and to continue generating copious amounts of free cash flow. At such low multiples of earnings and free cash flow, we view the stock price as reflecting overly pessimistic views from investors.

Cash was about 5% at the end of the month, reflecting our continuing ability to put capital to work at satisfactory rates of return. The future will tell, but we find the portfolio’s average valuation attractive, and remain confident that most of our companies will see higher revenues and earnings in 2011.

We wish you all a Happy and Prosperous New Year.

*Prices and performance: Yahoo Finance