Better Buy: Cisco Systems, Inc. vs. Microsoft

Cisco Systems (CSCO +2.55%) and Microsoft (MSFT 2.77%) have delivered excellent returns to investors over the past year. The networking equipment giant's and software king's shares have already surged 33% and 45%, respectively, and appear poised for further gains in the months ahead.

But which is the better buy today? Read on to find out.

Image source: Getty Images.

Competitive position 

Cisco is the world's largest manufacturer of network routers and switches. Yet while these were once high-growth markets during the early buildout of the internet, Cisco has since seen growth stall. In turn, the company has attempted to diversify its operations into more rapidly growing areas such as cybersecurity and wireless services. But these segments are relatively small compared to its core network hardware business, and Cisco's overall revenue has stagnated in recent years.

Microsoft, on the other hand, has recently enjoyed robust sales growth. Its Azure cloud computing platform, Office 365 productivity suite, and Dynamics 365 enterprise software provide it with three powerful growth drivers. The tech titan's venerable Windows franchise also continues to deliver solid results, and recent acquisition LinkedIn is helping to further boost growth. In all, Microsoft's revenue jumped 17% in the fourth quarter, up from 16% in Q3.

With strong competitive positions in multiple high-growth markets, Microsoft has more ways to win in the years ahead than Cisco Systems.

Advantage: Microsoft

Financial strength

Let's now take a look at some key financial metrics to see how these two tech giants compare.

Data Sources: Morningstar, Yahoo! Finance.

Cisco has a fortress-like balance sheet with $26 billion in net cash, but Microsoft's net cash position is even more impressive at $43 billion. In addition, Microsoft generates twice as much revenue and operating profits and three times as much operating cash flow as Cisco. Perhaps most importantly, Microsoft produces $20 billion more in annual free cash flow, even as it typically invests more than 10 times as much in value-creating capital expenditures as Cisco does on an annual basis. As such, Microsoft has a clear edge in terms of financial strength.

Advantage: Microsoft

Growth

Not only is Microsoft the more financially powerful business, it's also growing much faster. In fact, Microsoft's revenue is up by nearly 40% over the past half-decade, while Cisco's sales have remained essentially flat.

MSFT Revenue (TTM) data by YCharts

Microsoft's sales should continue to outpace that of Cisco for the foreseeable future. Analysts forecast that Microsoft will grow its revenue at a near 11% annual rate over the next two years.  Cisco, meanwhile, is projected to increase its sales by only about 3% per year during this same time, with its transition to a recurring revenue model and a slowdown in its government-related business expected to continue to weigh on its results.

Looking out even further, Wall Street expects Microsoft's earnings per share to rise by more than 12% annually  over the next five years, compared to about 9% annually for Cisco.

So in terms of both recent past and expected future growth, Microsoft is the clear leader.

Advantage: Microsoft

Valuation

Finally, let's check out some key stock valuation metrics for Cisco and Microsoft.

Data Source: Yahoo! Finance.

Cisco's shares are considerably less expensive than Microsoft's in terms of price-to-sales, price-to-free cash flow, and price-to-earnings ratios. Even if we account for Microsoft's greater expected earnings growth -- as we do with the price-to-earnings-to-growth (or PEG) ratio -- Cisco's shares are still more attractively priced. 

Advantage: Cisco Systems

The better buy is...

Cisco's stock may be cheaper, but Microsoft's stronger competitive positioning, superior financial strength, and more intriguing growth prospects make it the better long-term investment.