Cisco Systems is using small acquisitions and research focused on the Internet of Things to limit the impact of price competition in its traditional markets.

CISCO SYSTEMS INC (Nasdaq symbol CSCO; www.cisco.com) is a leading maker of hardware and software that links and manages computer networks. Its main products include routers, switches and Internet conferencing systems.

The company’s revenue rose 12.5%, from $43.2 billion in 2011 to $48.6 billion in 2013 (fiscal years end July 31). Revenue then declined to $47.1 billion in 2014, but improved to $49.2 billion in 2015. Overall earnings gained 25.7%, from $9.0 billion in 2011 to $11.4 billion in 2015. Cisco is an active buyer of its own shares. That’s why earnings per share rose at the faster rate of 36.4%, from $1.62 to $2.21.

In response to stronger competition from lower-cost, generic routers and switches, Cisco is shifting its focus to faster-growing markets such as computer security systems and software. The company is also developing products and software to connect more devices, such as home thermostats and appliances, to the Internet. This “Internet of Things” could total over 30 billion devices by 2020.

Cisco is now enhancing its security expertise with a series of acquisitions. These include its 2013 purchase of Soucrefire Inc. for $2.7 billion. That firm makes firewall software that protects computer networks from outside intruders. Cisco also paid $635 million in 2015 for OpenDNS, whose products block malicious websites.

More recently, the company agreed to buy Cloud-Lock for $293 million. That firm’s software helps guard sensitive corporate data stored on remote servers. It also improves security by restricting access to trusted devices and users.

Value Stocks: Small purchases limit risk

Expanding by acquisition adds risk: Cisco’s goodwill as of April 30, 2016, was $26.8 billion— a high 17% of its market cap. However, the company cuts the risk of a big writedown by targeting smaller firms that it can easily merge with its existing businesses.

Cisco’s high research spending is also helping it compete in a rapidly changing industry. It spent $1.63 billion (or 13.6% of its revenue) on research in the latest quarter, up 5.0% from $1.55 billion (or 12.7%).

The company’s strong balance sheet will continue to support its growth. As of April 30, 2016, it held cash and investments of $63.5 billion, or $12.62 a share. As well, its long-term debt of $24.4 billion is a moderate 16% of its market cap.

In addition, the company’s long-term relationships with many large corporations and governments will help it profit as they migrate to a cloud-computing platform. These clients will probably continue to use Cisco’s products instead of switching to smaller, unproven suppliers.

The stock trades at just 13.3 times the company’s projected 2016 earnings of $2.33 a share. The $1.04 dividend yields 3.4%.

Recommendation in Wall Street Stock Forecaster: BUY

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