Better Buy: Cisco Systems vs. Zoom Video Communications

In 2011, Eric Yuan left Cisco Systems (CSCO 0.06%) after realizing that customers were dissatisfied with the company's collaboration solutions. Believing he could create a better product, one that would make customers happy, he founded Zoom Video Communications (ZM 0.05%).

That decision has paid off many times over. Over the last year, Zoom's stock price is up 175%, while Cisco's is up 24%. However, it's smart to periodically reassess any investment thesis. So which of these tech stocks is the better buy today?

What you need to know about Cisco Systems

Cisco's sprawling business ranges from networking platforms like switching, routing, and wireless products to software and security solutions.

Image source: Getty Images.

For many years this tech giant has been the top dog in the ethernet switching and industrial routing markets, but increasing competition from Arista Networks has been a significant obstacle. In fact, Arista's software-centric approach has helped it take the lead in the 100 Gbps and 400 Gbps switching markets.

Meanwhile, between fiscal 2017 and 2020 (ended July 25, 2020), Cisco's networking revenue actually dropped 2%, and that trend has worsened so far in 2021. Going forward, the situation may continue to deteriorate, given that 400 Gbps switches are expected to represent a larger portion of the market over the next five years.

Cisco's applications business isn't doing much better. Despite double-digit growth from Cisco Webex, its video conferencing software, revenue from this segment dropped 4% in fiscal 2020 and is down 4% so far in 2021. Looking ahead, competition with Zoom is likely to be a significant problem, given that Zoom's revenue growth radically outpaced Cisco's during the pandemic.

If there is a bright spot, it's Cisco's security business. Here revenue is up 8% in the first six months of 2021. However, this represents a fraction of the company's total top line, and competitors like Zscaler have significantly more advanced network security platforms.

On the whole, Cisco's financial performance has been disappointing in recent years.

Data source: Cisco SEC filings. Note: Q2 2021 ended Jan. 23, 2021. TTM = trailing 12 months. CAGR = compound annual growth rate.

The takeaway is this: Cisco faces tough competition across virtually every market. Those headwinds have translated into slow or nonexistent growth, and I think that trend is likely to continue in the coming years.

What you need to know about Zoom Video Communications

Zoom's unified communications platform allows people to share content and interact through video, phone, and chat. Last year its cornerstone product, Zoom Meetings, benefited from strong adoption as the pandemic forced businesses to close and people to shelter at home.

Critical use cases like remote work, remote learning, and telemedicine helped Zoom grow its customer base by 470% in fiscal 2021 (ended Jan. 31, 2021). That powered revenue and free cash flow growth of 326% and 1,122%, respectively. It also helped Zoom establish itself as a leader in the video conferencing market.

In Zoom's SEC filings, the first tenet of its growth strategy is: Keep our existing customers happy. That customer-centric culture has led to strong customer retention. In fact, Zoom's net dollar expansion rate has exceeded 130% for the last 11 consecutive quarters. In other words, the average customer not only stays with Zoom, but also spends 30% more each year.

While last year certainly marked an acceleration in Zoom's growth trajectory, its financial performance has been impressive over a longer period of time.

Data source: Zoom SEC filings. CAGR = compound annual growth rate.

Going forward, Zoom has other products that should help its business maintain momentum. For instance, Zoom Phone is a cloud-based system that allows clients to make and receive calls through Zoom's platform. This means employees don't have to be at the office to make business calls -- instead, they can use their computers or mobile devices to make calls (through their business lines) from any internet-connected location.

As enterprises seek to simplify communications, Zoom's customer-centric strategy and expanding product portfolio should help the company win new clients (and keep existing ones). That tailwind should carry Zoom to even greater heights in the future.

The verdict

Zoom is the clear winner here. The company has demonstrated its ability to add and retain customers and grow its market share. In short, Yuan has accomplished exactly what he set out to do when he left Cisco 10 years ago.

Under his leadership, I believe this company will continue to grow in the years ahead -- and much more quickly than Cisco. That's why Zoom wins this contest.