Cisco Bear's Den
by Paul Larson ([email protected])
Boy, do I have a tough assignment here. Cisco was the fastest company to make it past $100 billion in market capitalization. This isn't a hype-job, either. Cisco has delivered nothing but superb results, and my argument will not take anything away from the past success of the company. What I will argue is that while Cisco's past story is as glorious as they get, today's price tag is quite lofty for a company showing slowing growth and increased competition.
Let's first talk a bit about just how steep that price tag is. Looking at some comparative data against the market gives a good indication of how expensively priced Cisco is.
| Cisco | Market | |
| Price to Earnings | 83.24x | 28.17x |
| Price to Sales | 13.38x | 1.32x |
| Price to Book | 17.27x | 3.53x |
| Price to Cash Flow | 73.13x | 12.28x |
| (Numbers courtesy of Media General, as of 12/6/98) | ||
Cisco, being the quality company that it is, certainly deserves a bit of a premium against the rest of the market. But triple the earnings multiple and ten-times the price-to-sales multiple of an already inflated market?
Fast forward a year and assume that Cisco meets its profit estimates. (A good assumption in my opinion, but an assumption nonetheless). Next year, assuming no further stock appreciation from here, you will be looking at a stock trading at nearly 55x trailing earnings that is only expected to grow earnings the following year at 25%, less than half the forward earnings multiple. In other words, the Fool Ratio is showing that the stock is quite overvalued at these levels.
Notice a trend here? The growth of the recent past pales compared to the growth further in the past. The estimated annual growth over the next five years of 30% is still quite impressive if achieved, but am I willing to pay an exorbitant 13x sales to get it in a maturing company? Sorry, there are certainly better bargains out there.
Next: The Bull Responds
Looking forward, the company is expected to grow earnings 55% this year (off a deflated fiscal 1998 earnings due to merger costs) and then the expected earnings growth slows to around 25% between 1999 and 2000. In table form it looks like this:
Cisco Forward Earnings Estimates
Year Ended
EPS
Forward Multiple
July 1999
$1.46
54.9x
July 2000
$1.82
44.1x
(Estimates courtesy of I/B/E/S at Fool.com)
High multiples of sales and earnings really don't frighten me in solitude. After all, many Rule Breakers in the initial stages of development, such as @Home <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ATHM)") else Response.Write("(NYSE: ATHM)") end if %> and even America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %>, defy conventional wisdom when it comes down to valuation. However, when the company is maturing and the growth slowing, valuation must start to enter the picture. Did I remember to mention Cisco's growth was slowing? Allow me to demonstrate with yet another table, this one readily available from Fool.com:
Growth Rates
1 Year
3 Year
5 Year
Sales %
31.34
55.89
67.11
EPS %
24.26
37.95
41.52
An important consideration is the fact that the future growth rates expected may be harder to attain than many are guessing. The only way the company can achieve those goals is by expanding outside of its core router business where Cisco currently dominates. This means Cisco is going to have to start seriously competing with the telecom heavyweights of Lucent <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LU)") else Response.Write("(NYSE: LU)") end if %>, Nortel Networks <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NT)") else Response.Write("(NYSE: NT)") end if %>, and Tellabs <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TLAB)") else Response.Write("(Nasdaq: TLAB)") end if %>. Needless to say, this is turf that is going to be vigorously defended by companies much more experienced and familiar with this particular market. Cisco's competition has been rather weak up to this point, but the competition only looks to get fiercer as Cisco attempts to grow.
I wanted to make a note concerning insider sales. Looking at what the insiders have been doing at the company (selling in droves) I do not exactly get filled with confidence about the stock. Insider sales alone are not sell signals, but the breadth, magnitude, and relatively low price many of the sales were made at really makes me wonder. The fact that those running Cisco only own 0.4% of the stock is not exactly reassuring either. They own less than one half of one percent! I like owning companies where those running the business have a large vested interest in doing their jobs well. To say Cisco's management owns a relatively paltry stake in the company is an understatement.
One final point, which should hopefully provoke some thoughts. The market capitalization of Cisco is greater than that of McDonalds <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MCD)") else Response.Write("(NYSE: MCD)") end if %>, Disney <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DIS)") else Response.Write("(NYSE: DIS)") end if %>, and Federal Express <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FDX)") else Response.Write("(NYSE: FDX)") end if %> combined. Is Cisco really worth more than all three of these companies put together? I don't know about you, but I have a hard time not getting sticker-shock when I look at Cisco.