SmartMoney: The Stock Market's Greatest Hits: These 10
Superstocks Are The Market's Undisputed Leaders, Representing
Nearly A Quarter Of The S&P 500's
5. Cisco Systems
Think Cisco is too expensive? Ten years ago this company hadn't even gone public. Today it is far and away the leader in Internet networking, holding the No. 1 or No. 2 share in every market in which it participates. And in the past two years, Cisco has posted close to 40 percent or better in revenue growth; earnings have increased by nearly 30 percent or more. That's how fast Internet networking is growing. That's how strong Cisco is within the sector. And that's why, at $71, it fetches a current P/E multiple of 57.
The question is, will it keep growing at this torrid pace long enough to justify today's price? After all, why buy Cisco when you can window-shop smaller tech issues and find "the next Cisco" trading at more digestible valuations?
The answer: Cisco has probably already acquired the company.
Next-generation technology is the secret to survival for any tech company. For that reason, many of them spend billions on research and development. Not Cisco. Given the value of its stock, deals are easy to make. In fact, startups are practically lining up at its door. Since 1993 it has acquired 41 companies, 11 in 1999 alone.
One of these -- Cerent -- has raised a few eyebrows. Critics claimed $6.9 billion was too high a price to pay for a company with revenue of $7.5 million -- and a single product that began to ship just last year. Yet Cerent's competitors trade at an average price/sales ratio of 59; what Cisco paid (in stock, naturally) amounts to a ratio of only 23, says Merrill Lynch analyst Michael Ching, based on his revenue estimates for 2000. But more important is what Cisco bought: Cerent's data-transmission equipment is based on the newest technology standard, optical transport. That's a market that Cisco estimates will grow to $17 billion by 2002. Cerent could capture $10 billion of that.
Critics gripe that Cisco hasn't invented anything significant since the router and that it uses acquisitions as a crutch. They're right. But some of Cisco's biggest competitors are adopting the same strategy: Nortel Networks bought Bay Networks in 1998, and Lucent Technologies bought Ascend Communications and Nexabit Networks earlier this year. Companies now look to networking firms to provide "end to end" service, with which they can find everything from hardware to software and networking-management solutions. Cisco is already in a position to deliver that; its competitors have to play catch-up.
Despite its price, Cisco is still the best bet in its sector. No other networking company is growing as fast. Lucent, arguably the next-best bet, is expected to increase earnings at 23 percent for each of the next five years; Cisco is expected to grow at 30 percent. And it boasts an impressive profit margin of 27.7 percent.
Ching recently upgraded his rating on Cisco to a buy. "While current valuations are rich, the relative P/E multiple is consistent with the range at which Cisco was trading in 1995," says Ching. At that time, the explosion in routers drove the stock. Today it's the Internet. "We believe that this is an even more powerful engine for future earnings growth." We do, too.
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