What Do You Get For Owning Cisco Systems Inc (NASDAQ:CSCO)?

I am writing today to help inform people who are new to the stock market and want to begin learning the link between Cisco Systems Inc (NASDAQ:CSCO)’s return fundamentals and stock market performance.

Purchasing Cisco Systems gives you an ownership stake in the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Thus, to understand how your money can grow by investing in Cisco Systems, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).

Check out our latest analysis for Cisco Systems

Cisco Systems's Return On Capital Employed

When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. The cost of missing out on another opportunity comes in the form of the potential long term gain you could've received, which is dependent on the gap between the return on capital you could've achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Cisco Systems is good at growing investor capital. CSCO’s ROCE is calculated below:

CSCO’s 16.30% ROCE means that for every $100 you invest, the company creates $16.3. A good ROCE hurdle you should aim for in your investments is 15%, which is exceeded by CSCO and means the company creates a solid amount of earnings on capital employed. If this can be sustained with good reinvestment opportunities or dividend distributions your capital has the potential to compound over time.

Not so fast

CSCO is efficient with the use of capital, but this is only the case if CSCO continues to maintain the presently healthy ROCE, which will change if the company either earns less or requires more capital to create earnings. Therefore, investors need to be confident in the trend of the inputs in the formula above, so that Cisco Systems will continue the solid returns. Looking three years in the past, it is evident that CSCO's ROCE has risen from 12.98%, indicating the company's capital returns have stengthened. Over the same period, EBT went from US$11.66b to US$13.33b and the amount of capital employed fell because of a decreased level of total assets and increase in current liabilities (more borrowed money) , which is an indication that Cisco Systems has increased the ROCE for investors by producing more earnings and using less capital.

Next Steps

ROCE for CSCO investors has grown in the last few years and is currently at a level that makes the company an attractive candidate that is capable of producing solid capital returns, and hence, an attractive return on investment. This is an ideal situation to be in, but return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. It's important to account for these factors because you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. Cisco Systems's fundamentals can be explored with the links I've provided below if you are interested, otherwise you can start looking at other high-performing stocks.

1. Future Outlook: What are well-informed industry analysts predicting for CSCO’s future growth? Take a look at our free research report of analyst consensus for CSCO’s outlook.
2. Valuation: What is CSCO worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether CSCO is currently mispriced by the market.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.