Cisco's Strong Performance Seen As Sector Bellwether

When Cisco Systems posted strong quarterly earnings last week, the good news buoyed the spirits of many investors--and not just the ones who hold shares of the networking company's stock.

It has long been considered a tech-industry bellwether, and the logic goes that Cisco's performance echoes the health of the IT industry in general. But other economic indicators may be showing that the rest of the sector still has a ways to go.

In Cisco's third quarter, ended May 1, the company posted net income of $1.2 billion, up 23% from a year earlier. Revenue rose 22% to $5.6 billion.

Sales were strong across the board, and orders from U.S. businesses rose roughly 15% quarter over quarter. Its advanced technology sectors, which include IP telephony, security, and wireless, were particularly bullish, all posting double-digit growth. Overall quarterly sales growth topped 4%; Cisco had predicted growth of between 1% and 3%.

CEO John Chambers, who usually errs on the side of restraint, painted a picture of a revived economy and rebounding business spending, saying in a conference call that he's more optimistic than he was last quarter and claiming that Cisco customers "are becoming more optimistic and starting to spend."Despite Cisco's good health, government data fails to give a consistent picture on the direction the larger communications-equipment sector is heading. For the 12 months ended in March, new orders for nondefense-communications equipment fell 5.1% from a year earlier, though shipments grew by 12.5%. Inventories during that period shrank by 14%, a healthy sign. In March, factories producing communications wares worked at only half capacity, a level that's been consistent this past year. The 50% capacity-utilization rate among communications makers in March is well below the 73% rate posted during the recession of the early 1990s. From 1972 through 2003, communications vendors averaged a factory-utilization rate of 78%, peaking at 87% in the mid-1990s.

So it may not be time to break out the bubbly just yet, though Cisco's numbers do portend improving fortunes. Crowell, Weedon & Co. analyst Chris Sessing says Cisco "has such a lion's share of several markets; if they're doing well, then obviously it equates to better spending overall."