Better Buy: Cisco Systems, Inc. vs. IBM

11/21/17

By Tim Brugger, MotleyFool

There are a lot of similarities between Cisco (NASDAQ:CSCO) and IBM (NYSE:IBM). Both have experienced some rough patches as they've plowed through their ongoing transitions. In the view of Cisco CEO Chuck Robbins, his company's future is in cloud infrastructure-as-a-service (IaaS) and its growing suite of software offerings. Meanwhile, IBM CEO Ginni Rometty has spent the last few years transforming her company away from its legacy hardware businesses to focus on what are widely viewed as rapid-growth markets. IBM has gone all in on its "strategic imperatives" -- the cloud, big data and cognitive computing, mobile, social, and data security.

Both tech giants are trading at bargain-basement prices, offer strong dividend yields, and are making progress in cutting costs. So which is the better buy today?

Image of a person touching a clear screen featuring a digital picture of a cloud branching out across multiple data points.

IMAGE SOURCE: IBM.

The case for IBM

Much of the news surrounding IBM recently involved Warren Buffett's decision to sell more shares. Investors took that to imply IBM had somehow stumbled, which helps to explain why its stock is down 6% since it shared third-quarter earnings. But don't let Buffett's decision deter you.

At 12.5 times earnings, IBM is priced well below Cisco's price-to-earnings ratio of about 19. And its 4% yield is twice that of the average 2% for dividend paying S&P 500 stocks. Beyond Buffett's moves to shed IBM stock, it has been hurt by its relatively slow transition toward significant growth in its strategic imperatives businesses, which led to a spate of quarterly revenue declines. But the rough days are nearing an end.

Over the trailing 12 months, strategic imperative sales climbed 10% to $34.9 billion. As of last quarter, the key units combined generated $8.8 billion in revenue, equal to 46% of IBM's $19.2 billion in total sales. Its cloud sales have grown to a trailing $15.8 billion annual run-rate.

Better still, IBM's cloud results are driven by its software and comprehensive data analytics. Outside of advertising, the cloud software-as-a-service (SaaS) market is expected to account for $46.3 billion in sales this year, a figure forecast to climb to $55.1 billion in 2018. IBM also cut its operating expenses 8% in 2017. Shareholders can expect it to be a leaner cloud-services provider in years to come.

Digitized picture of a city's cloverleaf highway lit up and night featuring multiple connected points.

IMAGE SOURCE: GETTY IMAGES.

The case for Cisco

Cisco has finally caught the attention of bullish investors following its strong fiscal first-quarter 2018 earnings results on Wednesday. Up 7% the past week, Cisco stock remains woefully undervalued. At about 19 times earnings, Cisco's P/E ratio is a relative steal compared to its peer average of 35.3. And its 3.2% dividend yield also compares favorably with its peers' 2.3% average.

While Cisco's $12.1 billion in total revenue beat expectations, its bottom line really impressed. Though total sales eased 2% compared to a year ago, Cisco reported a 4% increase in earnings per share (EPS) to $0.48. And like Rometty did at IBM, Robbins has initiated a cost-cutting plan in conjunction with Cisco's business transition.

The $4.67 billion Cisco shelled out in operating costs last quarter was 7% less year over year; such belt-tightening has become an on-going theme as its realigns itself. As positive as Cisco's top and bottom lines were in Q1, both take a back seat to its progress on its primary initiative: building a reliable foundation of recurring revenue. In addition to its IaaS focus, Cisco is expanding its cloud SaaS offerings to continually grow its revenue base: And it's working.

Last quarter, 32% of Cisco's $12.1 billion in sales -- $3.87 billion -- was driven by sales of its recurring revenue building software solutions. Not everyone was enamored with Cisco's decision to acquire BroadSoft (NASDAQ:BSFT) for $1.9 billion. But BroadSoft's cloud-based collaboration solution will immediately boost Cisco's base of recurring revenue.

And the better buy is...

As you may have gathered, I'm bullish on both IBM and Cisco. For investors with some patience, IBM is clearly on the right path, and its 4% dividend yield is nothing short of stellar. However, Cisco's forays into IaaS and SaaS are a bit further along than IBM's transition, and its recurring revenue base is growing each quarter. For these reasons, Cisco has the edge as the better buy.

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