If you are worried that Cisco is overvalued, here's something to consider.
Cisco's equity/share has grown at a remarkably steady 46.7 %/yr. ever since 1993. How much longer can Cisco maintain such rapid growth? There is still a lot of growth in Cisco's business, but growth has to slow eventually. Forecasting growth requires balancing the long-run potential of the business against the realization that Cisco can't grow at 46.7 %/yr. forever.
For the ultimate in flexibility, I prefer to forecast by drawing smooth curves on a sheet of graph paper. My current forecast curve has growth beginning at the current 46.7 %/yr. and slowing to 44.3 %/yr. in one year, to 41.2 %/yr. in 2 years, and to 31.1 %/yr. in 5 years. That growth projection brings equity/share up from $4.53 today to $7.14 in one year, $10.96 in two years, and $32.07 in 5 years.
At the current $130/share, the price/book ratio is an extraordinary 28.7. That ratio has to fall as growth slows. It will probably fall faster than the growth rate because investors will anticipate the slowdown in growth. My smooth-curve projection has the P/B ratio falling to 26.5 in one year, to 23.1 in 2 years, and to 14.0 in 5 years. The combination of the growth and P/B projections leads to stock prices of $189 in one year, $254 in two years, and $449 in 5 years.
An investor who insists on a 12% after-tax return can afford to pay $155 for Cisco if he intends to hold it one year, $175 if he intends to hold it 2 years, and $194 if he intends to hold Cisco 5 years.
For every one percentage point increase in the minimum after-tax return an investor insists on, he has to lower the most he can afford to pay by $2.26 if he intends to hold Cisco one year, $4.85 if he intends to hold it 2 years, and $12.09 if he intends to hold Cisco 5 years.
My conclusion: Cisco is a buy even at $130/share.
These estimates are extremely sensitive to the P/B forecast. If Cisco should have a bad quarter, the P/B ratio has plenty of room to fall faster than I have forecast.
John Malloy |
