Cisco Has Rallied in 2014. Is It Still a Good Investment?

Cisco Systems (CSCO -0.62%) rallied over 6% after it reported its numbers for the recent quarter and has risen over 11% in 2014. Now that Cisco's stock has realized considerable appreciation, is it fully valued even with potential growth in the future? If so, Cisco's competitors in the information technology and communications space such as Alcatel-Lucent (NYSE: ALU), Juniper Networks (JNPR -0.65%), or Ericsson (ERIC -0.76%) might be better investments at this point. 8

CSCO data by YCharts.

The recent appreciation in Cisco's stock is due in part to its 2014 third quarter revenue and earnings exceeding Wall Street's estimates. However, Cisco's rising stock price can also be largely attributed to a bright future for the company as well.

New markets and innovative technologies are part of Cisco's strategy to return to growth and the company is a major player in the "Internet of Everything." Cisco is in the early stages of building the world's largest Intercloud to facilitate the use of large amounts of data across applications, the analysis of data in real-time, and compliance with each country's laws related to sharing of data. Moreover, Cisco is increasing its presence in the Internet security realm with Managed Threat Defense. The security apparatus is designed to use predictive analytics in real-time in order to detect suspicious activity and harmful software across networks.

Historical performance
Cisco is coming off a good quarter, but how have it and the other four companies done over the last five years? The following chart shows the five-year averages for each company with respect to return on equity and return on capital. The last column shows if the company has been free cash flow positive each year over the past five years.

Data source: MSN Money & Morningstar. Returns on equity and capital in %.

Cisco is the clear outperformer among the group, with a five-year average ROE and ROC of 16.8% and 13.7%, respectively. None of the other companies really come close to the returns Cisco has managed to generate. Cisco's average ROE over the last five years is over 2.5 times more than Ericsson's, and its average ROC over that same time span is about 2.3 times that of Ericsson.

Cisco is the resounding investment choice among the four companies evaluated here in terms of investors returns.

Cisco, Juniper, and Ericsson are generating enough cash from their operations to fund their investments, while Alcatel-Lucent is not by a wide margin. In fact, Alcatel-Lucent has not been free cash flow positive since 2005. Therefore, calling a purchase of Alcatel-Lucent's stock an investment is a stretch by any means.

Excluding Alcatel-Lucent, the other three companies seem to be safe investments as they have generated positive free cash flow in their last five years.

Are you paying for good performance?
Cisco, Juniper, and Ericsson have yielded substantial cash flow and positive investor returns over the last five years, with Cisco being the best out of the group. Although Cisco seems to be the best looking back, does its current valuation make sense for a purchase of its stock, or would its competitors make better investment sense?

Data source: Morningstar & Yahoo! Finance.

Cisco is the cheapest stock on both a trailing and forward P/E basis, even with its outperformance in returns on equity and capital in comparison to the other companies. Investors seem to be ignoring the fact that Cisco has been a perennial outperformer; they are valuing Cisco's relatively underperforming competitors more than Cisco, and in my opinion, creating a compelling buying opportunity for Cisco's stock.

Looking forward five years, Cisco and Ericsson look richly valued considering their 5-year PEG ratios. A company with a 5-year PEG over 1 is considered overvalued on an increasing clip as the PEG increases. Juniper looks fairly valued with a PEG around 1, while Alcatel-Lucent looks attractive considering its 5-year PEG.

It's important to remember that the PEG valuations consider analyst estimates for the next five years. So even with a PEG significantly under one, I think Alcatel-Lucent is more speculation than investment given its past performance. I would feel safer investing in any of the other three companies, with Cisco as my top choice.

All three companies look respectably valued on an cash flow basis, except for Alcatel-Lucent with a negative P/CF. The S&P 500 trades at a P/CF of 11, so both Ericsson and Cisco look attractive compared to the market. Juniper, however, looks a little pricey with a P/CF of 13 compared to the market's 11.

Foolish takeaway
Cisco is the clear choice among these companies considering its performance over the last five years and its near-term and cash flow valuations. Alcatel-Lucent's attractive PEG is more of a bet on hopeful estimates for Alcatel-Lucent turning around its business from an awful past. Moreover, Juniper and Ericsson are decent companies, but fall short of Cisco with respect to investor returns and on most of the valuation metrics.

Cisco is also a major player in the Internet of Everything and innovative security solutions for networks. Therefore, Cisco is a solid investment within the telecommunications and networking sector.