Cisco Systems, Inc.'s (NASDAQ:CSCO) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Cisco Systems' (NASDAQ:CSCO) recent performance, when its stock has declined 7.4% over the past month. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Cisco Systems' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Cisco Systems

How Is ROE Calculated?

The formula for return on equity is:

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

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

30% = US$12b ÷ US$40b (Based on the trailing twelve months to July 2022).

The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.30.

What Is The Relationship Between ROE And 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 30% ROE

Firstly, we acknowledge that Cisco Systems has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. This probably laid the groundwork for Cisco Systems' moderate 18% net income growth seen over the past five years.

As a next step, we compared Cisco Systems' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 17% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Cisco Systems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Cisco Systems Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 54% (or a retention ratio of 46%) for Cisco Systems suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, Cisco Systems has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 41% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Conclusion

Overall, we are quite pleased with Cisco Systems' performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.

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