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Better Stock Buy: Zoom Video Communications vs. Cisco Systems

Motley Fool - Thu Aug 24, 8:12AM CDT

Zoom Video Communications(NASDAQ: ZM) probably wouldn't exist if its founder and CEO Eric Yuan had stayed at Cisco Systems(NASDAQ: CSCO). Yuan previously worked at Webex, a video conferencing start-up that was acquired by Cisco in 2007.

As a VP of Engineering at Cisco, Yuan pitched the development of a streamlined video conferencing app for mobile devices. When his idea was rejected, Yuan left Cisco and founded Zoom in 2011. Zoom's simple interface and catchy brand enabled it to challenge more complex enterprise-oriented platforms like Webex, and it became synonymous with video calls during the COVID-19 pandemic.

Three workers chatting with a fourth remotely through Zoom Rooms.

Image source: Zoom.

Zoom was one of the hottest growth stocks during the pandemic's height, but its growth fizzled out as more people returned to work and school. Cisco's growth remained relatively stable, even as it grappled with supply chain constraints throughout 2022. That's why Zoom's stock has declined nearly 80% over the past three years as Cisco's stock rose roughly 30%.

So will the networking giant remain a more reliable investment than the disruptive video conferencing challenger for the foreseeable future? Let's review their growth rates, valuations, and near-term challenges to decide.

Zoom's high-growth days are over

Zoom's revenue soared 88% in fiscal 2020 (which ended in January 2021), 326% in fiscal 2021, and 55% in fiscal 2022. But its top line grew a mere 7% in fiscal 2023, and it anticipates just 2% growth in fiscal 2024.

That abrupt slowdown can be attributed to the soft post-lockdown demand for video conferencing services, especially in Europe and Asia, as well as intense competition from Microsoft(NASDAQ: MSFT) Teams, Alphabet's (NASDAQ: GOOG)(NASDAQ: GOOGL) Google Meet, and Meta Platforms' Facebook Messenger in the crowded video conferencing space. The macro headwinds are also driving large enterprise customers to rein in their spending and sign shorter contracts.

Zoom's adjusted earnings per share (EPS) soared 483% in fiscal 2020, 854% in fiscal 2021, and 55% in fiscal 2022. But in fiscal 2023, its adjusted EPS dropped 14% as its revenue growth slowed down and the currency headwinds intensified. For fiscal 2024, it expects its adjusted EPS to grow 6% to 7% as its aggressive cost-cutting measures -- which included layoffs of 15% of its workers earlier this year -- stabilize its operating margins.

Zoom believes the expansion of its Virtual Agent and Contact Center, along with new AI features for summarizing and organizing meetings, will drive its long-term growth, widen its moat, and support its evolution into a more diversified cloud-based communications company.

However, investors who expect Zoom to return to generate stronger revenue and earnings growth in the near future will likely be disappointed. On the bright side, Zoom's low forward multiple of 16 could limit its downside potential in this tough market.

Cisco continues to deliver slow but steady growth

Cisco's revenue dropped 5% in fiscal 2020 (which ended in July 2020) as the pandemic disrupted its sales of networking hardware and software. But its revenue grew 1% in fiscal 2021 as those headwinds stabilized, then rose 3% in fiscal 2022 -- even as the growth of its hardware business was throttled by supply chain constraints.

Cisco's revenue climbed 11% in fiscal 2023 as it resolved its supply chain issues and finally satisfied the market's pent-up demand for new switches, routers, and wireless devices. The growth of that core hardware business offset the slower growth of its cybersecurity and collaboration services. It expects its revenue to rise 0% to 2% in fiscal 2024 as it faces tougher comparisons to its strong recovery throughout fiscal 2023.

Cisco's adjusted EPS grew 4% in fiscal 2020, stayed flat in fiscal 2021, and rose 4% in fiscal 2022 even as the supply chain constraints compressed its gross margins. Its adjusted EPS climbed 16% in fiscal 2023 as that pressure eased, and it anticipates 3% to 5% growth in fiscal 2024 as it continues cutting costs (after laying off about 5% of its workforce at the end of calendar 2022) and repurchasing more shares. It already bought back nearly a quarter of its shares over the past decade.

Unlike Zoom, Cisco isn't a high-growth stock that suddenly lost its momentum. It's simply a slow-growth stalwart that looks cheap at 14 times forward earnings and pays an attractive forward dividend yield of 2.8%.

The better buy: Cisco

Zoom's stock might be bottoming out, but it still hasn't proven that it can stay relevant as tech giants like Microsoft and Google creep into its backyard. Cisco won't generate jaw-dropping gains anytime soon, but its leadership of the networking hardware market, its stable growth, its low valuation, and its reliable dividend still make it a much better buy than Zoom.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Leo Sun has positions in Alphabet and Meta Platforms. The Motley Fool recommends Alphabet, Cisco Systems, Meta Platforms, Microsoft, and Zoom Video Communications. The Motley Fool has a disclosure policy.

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