Twenty years ago, the thought of a "technology" company being a safe, dividend-paying stock for a retirement portfolio seemed crazy. But a lot can change in twenty years. The two stocks in today's match-up -- Microsoft (MSFT 1.92%) and Cisco (CSCO 1.16%) -- are emblematic of that change.
These two titans have completely changed the way we do business around the world, either by providing the software (Microsoft) or the hardware (Cisco) that fundamentally helps us to communicate with one another.
Image source: Getty Images
Which is the better stock to buy today? That's impossible to answer with total certainty. But by approaching the question from three different angles, we can get a better idea of what we're paying for when we buy shares. Here's how the two companies stack up.
Sustainable competitive advantage
At the end of the day, there's nothing that plays a bigger role in a long-term investor's returns than the sustainable competitive advantages of his/her underlying holdings. Often referred to as a "moat" in investing circles, these can be very difficult to gauge.
In the simplest sense, a moat is the special something that keeps customers coming back to a single company, year after year, while forsaking the host of competitors who would gladly take that business away.
Microsoft's key moat is provided by both its brand -- ranked as the third-most valuable in the world by Forbes -- and high switching-costs. Microsoft's Office Suite has been around for over two decades; competitors have tried to create a better Word, PowerPoint, and Excel, but they have largely failed.
As these products -- as well as add-ons since then -- have become the standard way of communicating, they have become even more valuable. There's a strong incentive to continue using the suite -- who would want to start on a new Microsoft-Word-wannabe if that meant no one else had the operating system to read it?
Cisco, on the other hand, also benefits from a powerful brand, though it as ranked as "just" 15th globally. Cisco also benefits from high switching costs: the company's switches and routers have huge market share, and a company would have to overhaul virtually all of its hardware if it wanted to use a competitor.
That being said, the company is currently fighting off competition from Arista Networks (ANET 3.74%) -- founded by former Cisco employees -- which is offering up a better, more flexible solution to Cisco's hardware.
The company is responding by offering up subscription solutions that offer more reliable revenue streams, but given that Microsoft already has such revenue streams well established, I'm giving the nod here to Microsoft.
Winner = Microsoft
Financial fortitude
Investors in both companies realize that the days of ridiculous growth rates have long passed. As such, most want to see excess cash returned, either via share buybacks or dividend payouts.
But while those two things certainly have their place, there's something to be said for keeping a boring old pile of cash on hand. That's because every company -- at one point or another -- is going to go through an economic crisis. Those that have cash on hand can actually emerge stronger as a result of the crisis, because they can buyback shares on the cheap, acquire upstart rivals at bargain prices, or simply bleed the competition into bankruptcy by undercutting them on price.
Keeping in mind that Microsoft is valued at over three times the size of Cisco, here's how the two stack up.
|
Company |
Cash |
Debt |
Free Cash Flow |
|---|---|---|---|
|
Microsoft |
$147 billion |
$73 billion |
$33 billion |
|
Cisco |
$74 billion |
$26 billion |
$14 billion |
Data source: Yahoo! Finance, SEC filings. Cash represents cash, short- and long-term investments. Free cash flow presented on a trailing-12-month basis.
From 30,000 feet, these two companies are very similar. Relative to their sizes, Cisco actually has a stronger net cash position ($48 billion) than Microsoft ($74 billion), and slightly better free cash flow.
That being said, when a crisis hits, the absolute levels of cash and free cash flow make a big difference, especially when it comes to acquisition opportunities. That's why I'm calling this one a draw.
Winner = Tie
Valuation
Finally, we have valuation. Unfortunately, there's no one metric that will tell us if a company's stock is cheap or expensive. Instead, I find it best to consult a number of data points in building a more holistic picture.
|
Company |
P/E |
P/FCF |
PEG Ratio |
Dividend |
FCF Payout |
|---|---|---|---|---|---|
|
Microsoft |
26 |
22 |
2.2 |
1.9% |
37% |
| Cisco |
18 |
16 |
1.9 |
3% |
42% |
Data source: Yahoo! Finance, E*Trade. P/E represents calculations from non-GAAP earnings. Dividend yield reflects recently announced dividend increase for Cisco.
Cisco is the better bet on almost every metric. It has a cheaper absolute valuation, and it trades at a 14% discount to Microsoft even after accounting for growth opportunities. Both companies have lots of room to grow their dividends, but Cisco's is clearly superior in terms of its yield at today's prices.
Winner = Cisco
My winner is...
So there you have it: we have a tie. Usually, when this is the case, I side with the company with the wider moat. That means that the winner for today is Microsoft. If you're looking for a technology company with reliable revenue streams, a modest dividend, and a fair price, Microsoft is a good place to start.
