A judge in the provincial city of Kirov found the Kremlin critic and anti-corruption campaigner guilty at a trial that he insists was aimed at knocking him out of the election expected in March 2018.
Navalny, 40, announced in December that he would run for president, with Putin widely expected to compete and win a fourth term despite not confirming his candidacy yet.
Russian law bans people serving such a sentence from standing for office but Navalny -- who shot to prominence at the head of mass protests against Putin in 2011-2012 -- pledged to appeal the verdict and insisted he would keep on campaigning.
"According to the constitution I have a full right to take part in the elections and I will do that," Navalny said after the verdict.
"I will continue to represent the interests of people who want to see Russia a normal, honest and non-corrupt country."
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'Gang of thieves'
Navalny condemned the verdict as a "telegram from the Kremlin".
"Putin and his gang of thieves fear meeting us in elections," he wrote on Twitter. "And they are right: we will win."
The court was holding a retrial after Navalny and his co-defendant, businessman Pyotr Ofitserov were convicted of alleged embezzlement in 2013.
They allegedly defrauded the Kirov regional budget of 16 million rubles ($270,000, 253,000 euros) in a timber deal when Navalny was working as an advisor to the governor.
The European Court of Human Rights last year quashed the 2013 ruling, saying the men did not have a fair trial.
But Russia's supreme court then ordered that Navalny and Ofitserov face a retrial.
The judge on Wednesday gave Navalny and Ofitserov exactly the same sentences as before and used almost identical wording in a ruling he read out over more than three hours.
Navalny's suspended sentence will run out in about 18 months as he already served most of the five years sentence prior to the retrial, his lawyer Olga Mikhailova told journalists.
'Big risk' for Putin
The German foreign ministry voiced "concern" at the guilty verdict and insisted that Navalny "must continue to have the opportunity to participate in political life in Russia".
While Navalny insists he has enough legal avenues to overturn any ban on him running, the conviction should in theory now disqualify him from standing for president.
If that happens it would eliminate the most prominent and eloquent representative of the marginalised opposition to Putin.
The Kremlin has denied it is behind the case against Navalny, and Putin's spokesman Dmitry Peskov rejected claims that Navalny's possible exclusion would make the 2018 poll less legitimate.
But political analyst Alexander Morozov said that letting Navalny stand would be too much of a "big risk" as Putin must eventually start casting an eye towards finding a potential successor.
"Now the Kremlin only responds with police measures. Political dialogue is recognised as impossible," Morozov wrote in a comment on the RBK news site.
In a legal confusion that Navalny hopes to exploit, the Russian constitution says anyone who is not in prison can stand for election.
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Lawyer Vadim Kudryavtsev, who was not representing Navalny, told Kommersant FM radio that Navalny will be unable to stand if he loses his appeal, however.
If Navalny then takes his case back to the ECHR he is likely to win and get the verdict annulled again, the lawyer added.
After rising to fame with his fiery rhetoric at mass protests in Moscow Navalny finished runner-up to a Kremlin candidate in Moscow's 2013 mayoral race with 27 percent of the vote, an unprecendented amount for such a fierce Putin critic.
Navalny was allowed to compete in that race as he was appealing his first 2013 conviction.
He later spent months under house arrest over another fraud case that saw his brother Oleg jailed in December 2014 for three and a half years as a co-defendant.
The end of Navalny's latest trial comes as another member of Russia's marginalised opposition, Vladimir Kara-Murza, is in a coma with organ failure after suffering an "acute poisoning" last week, his wife said.
So far there has been no confirmation of foul play over the incident, which comes two years after an earlier suspected poisoning nearly killed Kara-Murza.
