Cisco Systems, Inc.'s (NASDAQ:CSCO) Stock Is Going Strong: Have Financials A Role To Play?

Cisco Systems (NASDAQ:CSCO) has had a great run on the share market with its stock up by a significant 21% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Cisco Systems' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Cisco Systems

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Cisco Systems is:

21% = US$9.4b ÷ US$45b (Based on the trailing twelve months to October 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.21 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Cisco Systems' Earnings Growth And 21% ROE

To begin with, Cisco Systems seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 18%. Despite this, Cisco Systems' five year net income growth was quite flat over the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital.

As a next step, we compared Cisco Systems' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 8.3% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. What is CSCO worth today? The intrinsic value infographic in our free research report helps visualize whether CSCO is currently mispriced by the market.

Is Cisco Systems Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 53% (implying that the company keeps only 47% of its income) of its business to reinvest into its business), most of Cisco Systems' profits are being paid to shareholders, which explains the absence of growth in earnings.

In addition, Cisco Systems has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 40% over the next three years. As a result, the expected drop in Cisco Systems' payout ratio explains the anticipated rise in the company's future ROE to 33%, over the same period.

Conclusion

In total, it does look like Cisco Systems has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.