Better Buy: Cisco Systems vs. Microsoft

Two of the best-known large-cap tech behemoths today are Microsoft and Cisco Systems. Both sell a mix of software and hardware products, but Microsoft is really, by and large, a software and services company, whereas Cisco is primarily a hardware company.

Software is the much more desirable business, as each company's recent results below will indicate. However, Cisco is also the far cheaper stock and sports a much higher dividend. Therefore, which company is the better buy today?

Microsoft vs. Cisco: The showdown. Image source: Getty Images.

Each company's main products

Microsoft is largely known for its Windows operating system but is actually fairly well-diversified today across operating systems, business software (including its Office and Dynamics productivity suites), and its high-growth Azure cloud-computing platform. It also owns LinkedIn, the leading business social network, which the company purchased in 2016, and Github, a platform that allows coders to collaborate together, which the company purchased in 2018. Microsoft also has its own high-end line of tablets and laptops under its Surface brand, as well as the Xbox gaming system, which is slated for a new console model later this year.

By contrast, Cisco is mainly known for its networking products across switches, routers, and networking access points. Cisco is known as an acquisition machine, specializing in smaller "tuck-in" acquisitions across cybersecurity, application diagnostics, and video conferencing.

Recent results

When comparing each company's recent results, it's really no contest. Microsoft wins hands down.

Cisco has struggled recently, as large corporate customers have been shy to invest heavily in new infrastructure under the cloud of the U.S.-China trade war. Though a "phase one" trade deal was agreed to in December and signed in January, Cisco's January-quarter numbers lagged well behind:

Data source: Company filings. Chart by author. YOY = year over year. EPS = earnings per share.

Microsoft has clearly benefited from the shift to cloud computing, with its Azure platform taking the most market share in the industry over the past year. Not only has Azure been coming in strong, logging 63.9% growth last year, but Microsoft has also transitioned its main Office and Dynamics software offerings into successful and modern software-as-a-service products delivered over the internet.

Meanwhile, Cisco should theoretically benefit from the cloud revolution, as well, as cloud increases the need for more connectivity and switches inside data centers. However, in times of economic uncertainty, customers may pull back on their investments, as happened last year. Moreover, Cisco is dealing with some tough competition in the form of Arista Networks, which has come on strong recently in data center switching, as well as "white box" switches made by customers themselves at lower cost, which utilize off-the-shelf basic components.

That cyclicality and competition were behind Cisco's subpar results last quarter. Cisco's core hardware offerings, which make up most of its revenue, actually declined by 8%, more than its overall company. However, the smaller cybersecurity segment grew 9%, and the services segment grew 5%. Though it's good to see Cisco diversifying into new products and services, it's also not great to see its "core" infrastructure platforms declining 8%.

Attempting to adapt, Cisco management recently unveiled its own silicon components that it would be willing to sell to customers for their own white-box solutions. It's an admirable move, for sure, but it's also one that Cisco is making out of necessity, not because it really wants to sell individual components over its high-priced integrated systems.

Valuations make the choice more difficult

Investors have been hip to the difference between these two technology giants, assigning each a very different valuation.

Data source: Yahoo! finance. Chart by author. P/E = price to earnings ratio.

As you can see, Cisco really outperforms Microsoft in terms of being the cheaper stock. However, note that Cisco's forward price-to-earnings ratio implies some healthy growth as the company comes back from a cyclical swoon.

However, the COVID-19 coronavirus could put a crimp in Cisco's outlook, as customers are probably likely to remain cautious on purchases and investments. Meanwhile, Microsoft's software-heavy portfolio is likely less affected by the virus slowdown.

In uncertain times, go with the better-performing company

Though the choice between Microsoft's impressive growth and Cisco's value may be daunting, in uncertain times such as these, I would always look to the higher-quality company with the bigger moat, as long as it's reasonably priced.

Hands down, that's Microsoft today. It might seem a tad pricey to some, but in today's low-interest rate world and considering the company's ascension in the high-growth cloud-computing industry, it's the clear pick for me. Besides, I don't think Microsoft is even quite as expensive as it looks at first glance.