Every investor can appreciate a stock that consistently beats the Street without getting ahead of its fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with improving financial metrics that support strong price growth. Let’s take a look at what Cisco Systems, Inc. (NASDAQ:CSCO)‘s recent results tell us about its potential for future gains.
What the numbers tell you
The graphs you’re about to see tell Cisco’s story, and we’ll be grading the quality of that story in several ways.
A company that generates more earnings per share over time, regardless of the number of shares outstanding, is heading in the right direction. If Cisco’s share price has kept pace with its earnings growth, that’s another good sign that its stock can move higher.
Is Cisco managing its resources well? A company’s return on equity should be improving, and its debt-to-equity ratio declining, if it’s to earn our approval.
Healthy dividends are always welcome, so we’ll also make sure that Cisco’s dividend payouts are increasing, but at a level that can be sustained by its free cash flow.
By the numbers
Now, let’s take a look at Cisco’s key statistics:
CSCO Total Return Price data by YCharts.
| Criteria | 3-Year* Change | Grade |
|---|---|---|
| Revenue growth > 30% | 34.1% | Pass |
| Improving profit margin | (11.1%) | Fail |
| Free cash flow growth > Net income growth | 33.5% vs. 46.1% | Fail |
| Improving EPS | 58.2% | Pass |
| Stock growth (+ 15%) < EPS growth | (4%) vs. 58.2% | Pass |
Source: YCharts. *Period begins at end of Q3 2009.
CSCO Return on Equity data by YCharts.
| Criteria | 3-Year* Change | Grade |
|---|---|---|
| Improving return on equity | 8.9% | Pass |
| Declining debt to equity | 20.7% | Fail |
| Dividend growth > 25% | 133.3% | Pass |
| Free cash flow payout ratio < 50% | 18.3% | Pass |
Source: YCharts. *Period begins at end of Q3 2009.
How we got here and where we’re going
Six out of nine passing grades isn’t bad, but for a company in Cisco’s position, it’s a little disappointing. The only truly worrisome failing grade here is the one granted to Cisco on the profit margin test. Its free cash flow levels are quite close to its net income, and could easily pull ahead by the time we examine the company again. Cisco has three times as much cash as it carries in total debt, so that should not be a major issue going forward. Now, how can Cisco turn its flagging profit margins around for 2013?
