Please ensure Javascript is enabled for purposes of website accessibility

Better Stock: Microsoft Corporation (MSFT) vs. Cisco Systems, Inc. (CSCO)

By Brian Stoffel - Feb 21, 2018 at 10:31AM

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 tie-breaker signals one as a better buy than the other.

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 -1.05%) and Cisco (CSCO -0.75%) -- 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.

Smart city and telecommunication network concept.

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 -0.95%) -- 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.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$264.89 (-1.05%) $-2.81
Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
CSCO
$43.77 (-0.75%) $0.33
Arista Networks, Inc. Stock Quote
Arista Networks, Inc.
ANET
$98.87 (-0.95%) $0.95

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
332%
 
S&P 500 Returns
115%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 06/28/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.