Re: Cisco valuation (and market valuations in general)
Hey JW.
Good post on Cisco. I agree with your assessment. So why do investors keep stepping up to buy an overpriced Gorilla? I think its simply because it has worked in the past. Just as nobody got fired for buying Cisco routers, no fund manager got fired for buying Cisco stock. And we have to give credit where its due: Cisco management has a very consistent history of exceeding expectations, and a very visible position of strength to compete from.
I wanted to pass on a tool that I use sometimes to do a reality check on stocks I own. I also use it to make final selections when I have more want-to-owns than I have funds available. (All right brain and momo types will probably want to hit the next button now...)
To do a periodic valuations check, I use an online discounted cash flow calculator available from Quicken.
Inputs are: current earnings, estimated earnings growth, and discount rate. The model takes care of number of shares outstanding, total debt outstanding, and the required number crunching. (The discount rate that returns a fair value near the current price is the investor's estimated return if they buy at today's price).
Here's a link to Cisco figures using the model.
quicken.excite.com
Using analysts consensus estimates for the future earnings growth rate of 30% and a 15% discount rate yields a fair value on the stock of $28. Compare to latest CSCO quote at $67.75.
The investor's return on Cisco implied by today's price of 67.75 and a 30% earnings growth rate is 5.0%. You can confirm this by plugging that figure into the model...it will return $67.00 or so.
When I do this same exercise for a few other tech names, the discount rates that show up repeatedly are in the range of 15-18%.
That tells me the market is pricing these issues pretty rationally, given the prevailing estimates of their future growth.
Warning: Garbage In, Garbage Out applies here. If the estimated growth rate is off, you are lost in the woods without a map.
Examples:
JDSU disc rate = 19%
CREE = 22.5%
NTAP = 16%
EMC = 16%
Some higher, some lower...riskier stocks and less assured business models tend to get higher discount rates.
So, bottom line, Cisco is priced to yield a T-bill type return IF they hit their numbers for the next 10 years.
If they exceed the analysts expectations, (as they have consistently done in the past) returns should be a bit higher. For example...at 35% growth instead of 30%, the discount rate climbs to 9%. That's probably not too unrealistic, IMHO.
If they stumble, we all know what happens...
Just wanted to show that a number crunching approach based on the present value of future cash flows yields a very similar conclusion to the one you arrived at via a quick and dirty comparison of Cisco's PE to NT and LU.
One note of caution: If anyone wants to use this model, you must override the earnings figures it provides when there are distorting, one-time items in the current period earnings (i.e JDSU and their acquisition writeoffs). The way to do this is get the estimated earnings per share for the current year from a Zack's or whoever (which will generally exclude non-recurring charges) and multiply that by the number of shares outstanding. This gives you base period earnings to plug into the model.
OK...enough Finance 301...and back to Time Compression! :-)
Brian
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