Better buy: Cisco Systems vs. Microsoft

Which tech giant is a better long-term investment?

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Cisco (NASDAQ: CSCO) and Microsoft (NASDAQ: MSFT) are generally considered solid long-term investments for conservative investors. Both tech giants have wide moats -- Cisco is the world's top maker of networking hardware, and Microsoft is its biggest software company.

But over the past 12 months, Cisco's stock only rose by the low single digits as Microsoft's stock soared more than 30%. Does that trend indicate that the former is a weaker investment than the latter? Let's dig deeper to find out.

Cisco's strengths and weaknesses

Cisco's core infrastructure business -- which sells routers, switches, wireless hardware, and other hardware products -- is a slow-growth one that faces tough competition from rivals like Huawei, Arista Networks, Hewlett Packard Enterprise, and Juniper Networks.

Cisco offsets that slower growth with two main strategies: expanding its portfolio of higher-growth applications and security software (16% of its revenue last quarter) with new products and acquisitions, and bundling those services with its hardware into cost-effective packages.

Those strategies shore up Cisco's defenses against its rivals, but it still faces two long term challenges. First, it faces softer enterprise spending in China, the U.S., and the UK as several big macro issues -- like the trade war and Brexit -- remain unresolved.

Second, a growing number of big enterprise customers are pivoting toward cheaper "white box" alternatives to Cisco's hardware, which run on open-source software and rely on cloud-based SDN (software-defined networking) to do the heavy lifting. Cisco could struggle to lock in those customers as they break free from its hardware and software ecosystem.

Microsoft's strengths and weaknesses

Microsoft owns a sprawling portfolio of software and hardware products, but most of its growth comes from its cloud unit -- which generates most of its revenue from Office 365, its Dynamics CRM (customer relationship management) platform, and Azure.

Azure, the second largest cloud infrastructure platform after Amazon (NASDAQ: AMZN) Web Services (AWS), is the cloud unit's core growth engine. Its revenue surged 68% annually on a constant currency basis last quarter, which boosted Microsoft's total commercial cloud revenue 39% to $11 billion, or 36% of its top line.

Azure's growth is supported by three main tailwinds: the rising use of cloud-based services, the increasing reluctance of Amazon's rivals (especially retailers) to use AWS, and the expansion of its ecosystem with new availability zones and services.

Microsoft's weakest business in recent quarters was its gaming unit, due to the maturation of the current console generation which started nearly six years ago. However, that business should recover next year when Microsoft launches its next-gen Xbox.

Which company is growing faster?

Cisco's revenue and adjusted earnings rose 7% and 20%, respectively, in fiscal 2019 (which ended on July 27). However, analysts anticipate just 2% revenue growth and 7% earnings growth this year, due to tougher year-over-year comparisons, slower enterprise spending, and ongoing challenges in China.

China only accounts for a small percentage of Cisco's sales, but the region's revenue is falling sharply due to a trade war-related backlash, which locked the company out of bids for network upgrades at state-backed enterprises.

Microsoft's revenue and adjusted earnings rose 14% and 22%, respectively, in fiscal 2019 (which ended on June 30). Wall Street expects its revenue to rise 11% and for its earnings to improve 10% this year.

That forecast assumes that Microsoft's commercial cloud revenue will keep rising, that its new Surface products will attract new customers, and that its gaming ecosystem -- which includes both consoles and popular subscription services like Xbox Game Pass -- will keep expanding.

The dividends and valuations

Cisco started paying a dividend in 2011, and it's raised its payout every subsequent year. It spent 40% of its free cash flow (FCF) on its dividend over the past 12 months, and currently pays a forward yield of 3%. Its stock currently trades at 13 times forward earnings.

Microsoft hiked its dividend annually for 15 straight years. It spent just 36% of its FCF on that payout over the past 12 months, and currently pays a forward yield of 1.5%. Microsoft currently trades at 24 times forward earnings.

Cisco's lower multiple and higher yield might look more appealing to value-seeking investors, but Microsoft's double-digit revenue and earnings growth also justify its higher valuation.

The winner: Microsoft

Cisco and Microsoft are still both stable long-term investments. But if I had to choose one at current prices, I'd pick Microsoft because it has a better diversified business and more irons in the fire (particularly Azure and the next Xbox), and faces fewer near-term headwinds.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Leo Sun owns shares of Amazon and Cisco Systems. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Microsoft. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has the following options: long January 2021 $85 calls on Microsoft. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on International Stock News

A man looking at his laptop and thinking.
International Stock News

Why Alphabet stock was sliding today

Let's take a look.

Read more »

A man looking at his laptop and thinking.
International Stock News

Nvidia's stock was down despite its amazing earnings. Here's what history says is coming next

Although it might seem to defy logic, it's not an uncommon phenomenon.

Read more »

A woman holds a soldering tool as she sits in front of a computer screen while working on the manufacturing of technology equipment in a laboratory environment.
International Stock News

Nvidia share price slips despite 94% revenue growth

Q3 earnings beat expectations, but what about guidance?

Read more »

high, climbing, record high
International Stock News

Could the S&P 500 Index hit 6,500 by the end of 2025?

Could the index climb higher?

Read more »

a small child holds his chin with his head on the side in a serious thinking pose against a background of graphic question marks and a yellow lightbulb.
International Stock News

Is it too late to buy Nvidia shares?

Is Nvidia stock a buy ahead of its third-quarter earnings report tomorrow?

Read more »

a group of people stand examining a large glowing cystral ball held in the hands of one of the group members while the others regard it with various expressions of wonder, curiousity and scepticism.
International Stock News

Here's what to expect from Nvidia on November 20

Can Nvidia score another win?

Read more »

Two people lazing in deck chairs on a beautiful sandy beach through their hands up in the air.
International Stock News

2 no-brainer Warren Buffett stocks to buy right now

While replicating Buffett's success isn't possible, there are a handful of his investments that are no-brainer buys.

Read more »

A man with a beard and wearing dark sunglasses and a beanie head covering raises a fist in happy celebration as he sits at is computer in a home environment.
International Stock News

3 reasons to buy Nvidia stock before November 20

This week marks a big moment for tech investors as perhaps the most anticipated earnings of the year will be…

Read more »