Cisco Systems, Inc.'s (NASDAQ:CSCO) Stock Has Shown A Decent Performance: Have Financials A Role To Play?

Cisco Systems' (NASDAQ:CSCO) stock is up by 7.3% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Cisco Systems' ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Cisco Systems

How Do You 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:

27% = US$11b ÷ US$41b (Based on the trailing twelve months to January 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.27.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 27% ROE

Firstly, we acknowledge that Cisco Systems has a significantly high ROE. Secondly, even when compared to the industry average of 11% the company's ROE is quite impressive. As a result, Cisco Systems' exceptional 21% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing with the industry net income growth, we found that Cisco Systems' reported growth was lower than the industry growth of 30% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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?

The high three-year median payout ratio of 55% (implying that it keeps only 45% of profits) for Cisco Systems suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Besides, Cisco Systems has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 38% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we feel that Cisco Systems certainly does have some positive factors to consider. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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