Cisco Systems (NASDAQ:CSCO) posted better-than-expected fiscal third-quarter results following the market close Wednesday. Yet because of management's disappointing outlook for the current quarter, the stock dropped during after-hours trading.

The tech giant is still in the midst of a multiyear transition as it shifts its focus away from its legacy on-premises hardware networking business and toward its growing subscription-based software portfolio. So is this latest report an indication that investors should stay away from the company, or should they buy the dip and hope for it to have a brighter future beyond the short-term uncertainties? 

Unexciting short-term results

Thanks to strong demand across its broad portfolio, revenue during Cisco's fiscal Q3, which ended May 1, increased by 7% year over year to $12.8 billion. Even if you exclude the extra revenue contributions from acquisitions during that quarter, revenue growth would have reached approximately 6.1%, comfortably above management's guidance for growth in the range of 3.5% to 5.5%.

Colleagues working together in a data center.

Image source: Getty Images.

In particular, and consistent with the previous quarters, the company's cybersecurity segment delivered strong top-line performance. Its revenue rose 13% year over year to $875 million, partly thanks to its cloud platform Umbrella and identity solution Duo Identity.

Also, Cisco reaffirmed the recent recovery of its webscale cloud business. During previous years, Cisco failed to propose flexible and cost-effective networking solutions for cloud giants, which resulted in it losing market share to innovative cloud networking vendor Arista Networks in the attractive high-speed data center switching market. But those challenges seem to be behind it. During the earnings call, CEO Chuck Robbins indicated that Cisco's webscale business grew 25% year over year on a tough comparison from the prior-year quarter's growth, which was above 70%.

However, overall, those better-than-expected fiscal third-quarter results remained unexciting. Revenue had declined by 7.5% year over year during the prior-year quarter, which provided an easy top-line comparison. 

For the current quarter, management anticipates that revenue will increase by 6% to 8% year over year, as more customers look to update their networking infrastructures to allow their employees to work securely from anywhere.

But because of supply chain constraints across the industry, Cisco expects its non-GAAP (adjusted) gross margin will drop to a range of 63% to 64%, down by 150 basis points at the midpoint compared to the year before. That news, too, disappointed investors.  

Cisco's transition is materializing

Because of Cisco's uninspiring top-line performance and short-term outlook, the stock is now trading at modest valuations, with a forward enterprise value-to-sales ratio of 4.2 and a forward price-to-earnings ratio of 15.1. These indicate the market doesn't expect the company's results to significantly improve in the near future. 

Yet Cisco seems positioned to succeed in transforming itself from a business focused on its legacy hardware portfolio into one powered largely by subscription-based software revenues.

During the last quarter, revenue from software reached $3.8 billion, up 13% year over year. And 81% of that software was sold as a subscription, up from 76% in the previous quarter. I expect this transition to intensify over the next several quarters. In March, Cisco revealed its new as-a-service offering, Cisco Plus, which allows customers to purchase its hardware, software, and services under simplified and unified subscriptions.

Besides, in addition to its internal developments, the company is poised to capture growth opportunities in its core networking and security businesses with acquisitions it can leverage thanks to its large sales and marketing footprint. Case in point -- following three acquisitions it completed during the last quarter, the company announced this month its intention to buy Kenna Security, a deal that will beef up its cybersecurity offering with vulnerability management capabilities.

Cisco's rock-solid balance sheet, with $12.0 billion of cash, cash equivalents, and investments in excess of its total debt at the end of the last quarter, should support additional similar acquisitions. 

Thus, despite its unexciting short-term results, investors should consider buying Cisco stock to take advantage of the company's modest valuation relative to its encouraging longer-term outlook as it pivots away from its legacy portfolio and business model.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.