Cisco trades at $72.80 and has moved in lockstep with the market. Its shares have returned 27% over the last six months while the S&P 500 has gained 23.9%.
Is now the time to buy Cisco, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free for active Edge members.
Why Is Cisco Not Exciting?
We're swiping left on Cisco for now. Here are three reasons you should be careful with CSCO and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
Examining a company’s long-term performance can provide clues about its quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Unfortunately, Cisco’s 2.8% annualized revenue growth over the last five years was sluggish. This was below our standards.
2. Free Cash Flow Margin Dropping
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Cisco’s margin dropped by 6.2 percentage points over the last five years. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. If the longer-term trend returns, it could signal increasing investment needs and capital intensity. Cisco’s free cash flow margin for the trailing 12 months was 23.5%.
3. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Cisco’s ROIC has decreased significantly over the last few years. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
Cisco isn’t a terrible business, but it doesn’t pass our bar. That said, the stock currently trades at 18× forward P/E (or $72.80 per share). Beauty is in the eye of the beholder, but our analysis shows the upside isn’t great compared to the potential downside. We're fairly confident there are better investments elsewhere. We’d recommend looking at the most dominant software business in the world.
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