Cisco Systems Inc. is a large provider of networking equipment, based in Silicon Valley, California. In August 2004, it released financial results for the quarter ended July 30, 2004. Its revenues increased by 26% over the same quarter of 2003. Its net income for the quarter was $1.4 billion or 21 cents per share, a 41% increase over the same quarter in 2003 and 5% in excess of the average analysts’ forecast of 20cents. However, Cisco’s share price fell almost 18% to $18.29 following the announcement. This fall in share price seems contrary to the results of Ball &Brown [1968] and subsequent researchers, who have documented a positive market response to good earnings news. Analysis of other financial statement information revealed the following. Inventory turnover declined to 6.4 from 6.8 in 2003, gross margin declined slightly, the order backlog was down and, while revenue was growing, its rate of growth appeared to decline. Also, several analysts commented on an increase in inventories, suggesting lower accrual quality to the extent these inventories would be slow in selling. Furthermore, Cisco’s CEO, commenting on the quarter’s results, mentioned that the firm’s customers were becoming more cautious about spending. Required: b) Is the market reaction in the case of Cisco consistent with efficiency? Explain why or why not.
Cisco Systems Inc. is a large provider of networking equipment, based in Silicon Valley, California. In August 2004, it released financial results for the quarter ended July 30, 2004. Its revenues increased by 26% over the same quarter of 2003. Its net income for the quarter was $1.4 billion or 21 cents per share, a 41% increase over the same quarter in 2003 and 5% in excess of the average analysts’
Analysis of other financial statement information revealed the following. Inventory turnover declined to 6.4 from 6.8 in 2003, gross margin declined slightly, the order backlog was down and, while revenue was growing, its rate of growth appeared to decline. Also, several analysts commented on an increase in inventories, suggesting lower accrual quality to the extent these inventories would be slow in selling. Furthermore, Cisco’s CEO, commenting on the quarter’s results, mentioned that the firm’s customers were becoming more cautious about spending.
Required:
b) Is the market reaction in the case of Cisco consistent with efficiency? Explain why or why not.
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