Is Cisco Systems Stock a Buy Now?

Cisco Systems' (CSCO -0.27%) stock price plunged 13% during after-hours trading on May 18 following its third-quarter earnings release.

The networking device maker's revenue stayed nearly flat year over year at $12.8 billion, which missed analysts' expectations by $500 million. Its adjusted earnings increased 5% to $0.87 per share, which cleared estimates by a penny.

But for the fourth quarter, Cisco expects its revenue to decline 1%-5.5% year over year, and for its adjusted EPS to drop 0%-9.5%. For the full year, it expects its revenue to rise just 2%-3%, compared to its prior outlook of 5.5%-6.5% growth, and for its adjusted EPS to grow just 2.5%-5% -- which was also below its previous guidance for 6.2%-7.8% growth.

Image source: Getty Images.

Cisco's mixed third-quarter numbers and grim guidance were disappointing, but did investors overreact and prematurely dump this blue-chip tech stock? 

Cisco fell short of its own expectations

Cisco's dim outlook suggests it set the bar too high during its investor day presentation last September.

At the time, Cisco predicted its annual revenue would grow at a compound annual growth rate (CAGR) of 5% to 7% between fiscal 2021 and 2025, and that its adjusted EPS would also increase at a CAGR of 5%-7%.

It planned to hit those targets by expanding its higher-margin subscriptions from 44% of its revenue in fiscal 2021 to 50% in fiscal 2025, and by expanding its total addressable market (TAM) beyond its legacy networking switches and routers with new products for adjacent markets.

Checking in on Cisco's six new businesses

Starting in fiscal 2022, Cisco restructured its four reporting segments (infrastructure platforms, applications, security, and services) into six new ones -- secure, agile networks (which generated 46% of its revenue in the first nine months of fiscal 2022); internet for the future (10%); collaboration (9%); end-to-end security (7%); optimized application experiences (1%); and services (26%) -- to reflect that strategic shift. Here's how those six businesses fared over the past three quarters:

Data source: Cisco. *Previously known as Hybrid Work in Q1 and Q2.

The growth of its secure, agile networks division cooled off as it sold fewer enterprise routers, and the growth of its internet for the future business decelerated after it lapped its acquisition of Acacia Communications (which closed last March).

Its collaboration business struggled as the shift to hybrid and remote work throttled the market's demand for its on-premise teleconferencing products. Its Webex video conferencing platform also failed to keep pace with nimbler competitors like Zoom Video Communications (ZM -0.34%). By comparison, Zoom's revenue rose 55% in its latest fiscal year.

Cisco's security business continued to generate steady growth, albeit at a slower clip than many other stand-alone cybersecurity companies. Its tiny optimized application experiences business -- which has been mainly supported by acquisitions -- continued growing as its newer cloud-based ThousandEyes and Intersight services gained more customers.

Cisco expects its total revenue to decline in the fourth quarter as the Russo-Ukrainian war, COVID-19 lockdowns in China, and supply chain challenges throttle its near-term sales.

During the conference call, CEO Chuck Robbins said there was still "strong demand" for Cisco's products, but warned that its near-term revenue growth would be "less dependent on demand and more dependent on the supply availability" in an "increasingly complex environment."

Shrinking margins and slowing earnings growth

As Cisco's revenue growth decelerated, its adjusted gross margin declined sequentially and year over year, as its shrinking product gross margins offset a slight expansion of its service gross margins.

Data source: Cisco.

Cisco attributes its declining product gross margins to higher component, freight, and logistics costs related to the ongoing supply chain constraints. It expects those headwinds to reduce its total adjusted gross margin to 64%-65% in the fourth quarter.

Cisco's stock is cheap for obvious reasons

Cisco's stock now trades at 13 times the midpoint of its EPS estimate for fiscal 2022, and it pays a high forward dividend yield of 3.6%. That low valuation and high yield might limit its downside potential, but it will likely remain in the penalty box until its revenue growth and margins stabilize again.

Cisco's business is still broadly stable, but investors should avoid its stock for now and stick with more reliable tech stocks in this challenging market.