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Technology Stocks : Cisco Systems, Inc. (CSCO)

CSCO 76.00

+2.2%

11:28 AM EST

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To: The Phoenix who wrote (45543)	12/30/2000 2:20:56 PM
From: The Phoenix	Read Replies (1) of 77400

Some idle thoughts on valuation. Many of those that are bearish on CSCO point to the use of pro-forma earnings and suggest that the actual earnings are a better indicator of what the company is generating. While this is an acurate picture of the bottom line it ignores the use of funds. What really is occuring is that the "actual earnings" are diminished by the fact that "unrealized earnings" are being pumped back into the company in the form of minority investments and increased R&D. So, what we really experiencing when we look look at the difference between actual earnings and pro-forma is the opportunity cost. That is Cisco appears to be more intent on investing for the future than generating big numbers on the bottom line today. The industry is still in it's infancy and so it's incumbent upon Cisco management (and it is their duty to shareholders) to continue to innovate and acquire where neccessary. While this does have an impact on the "actual earnings" this is a fundamental requirement in a developing market. So, actual earnings are the result of opportunity costs and if the company chose to slow the pace of acquisitions or spend the industry average on R&D then the actual earnings would be far higher... and in fact close to in line with Pro-forma. The message here is that looking at actual earnings misses the point... it attempts to compare a growth company in a growth market where acquitisions are key to a mature company in a mature market. This can't be done easily. In fact pro-forma is a better measure of earnings since it includes earnings (and costs) that are a result of the opportunity costs... a result of not pushing earnings to the bottom line each quarter. Hiding your head in the sand wrt to Pro-forma misses the point of the business as a going concern. Now...to the point of valuations. Yes indeed, they were high last year but now the valuations - given growth are well in line. In fact using pro-forma earnings the current PE for Cisco is below 50 and yet revenue growth is 60%+ and earnings growth is over 50%. This would seem to indicate - purely from a valuation perspective that CSCO is priced right...perhaps a little low but about right. Going forward here's what it looks like if you buy into the valuation only scenarios and you buy into the estimates that CSCO will have 33.8% earnings growth over the next 5 years... FY01 results Earnings .78 Revenues $30B PE 50 Stock Price $39 FY02 results Earnings $1.04 Revenues $39B PE 45 Stock Price $47 (21% increase) FY03 results Earnings $1.40 Revenues $50B (Dovetails with Chamber's target) PE 40 Stock Price $56 (19% increase) FY04 Earnings $1.87 Revenues $65B PE 35 Stock Price $65 (16% increase) FY05 Earnings $2.50 Revenues $84B PE 30 (below the growth rate) Stock Price $75 (15% increase) Again these numbers are very conservative. Revenue growth is shown at 30% when this past year it was 60%+. Earnings growth used is the 33.8% in YHOO and we know that CSCO always beats by a penny....and that recent historical earnings growth has been far higher. Finally I have systematically eroded the PE to a point where in FY05 the PE is actually below the earnings growth rate. This is purely a valuation perspective only.... and ignores the market conditions. There are two types of market conditions.. macro and sectorwide. From a macro perspective the market is a leading indicator. The market sold off in March and through the summer and now here were are looking over the edge at a possible recession. The market will be a leading indicator out of this down cycle. Engery prices are easing, monetary policy is turning dovish as inflation worries wane. Furthermore when we look at macro factors (when considering a multinational company) we have to look outside the boarders... and internationally the econmics look sound... most importantly while there may be softness in some economies others will do well. From a sectorwide point of view the need for communications products for wireless and optical build out - both domestically and internationally - for enterprise and carrier customers continues unabated. Some will point to specific areas of capex slowdowns or CLEC failures... but the net net is that while some companies will fail others will prosper. I'm sure that the failure of Montgomery Wards is a benefit to companies like Sears. The same will hold true in the carrier markets. Dot Com failures will continue but Dot Com's used little in the way of communication infrastructure - servers yet... but not switches, routers, aggregation etc... The bottom line is that macro factors will begin to look more favorable going forward as we work through 01. Sector specifics look very strong as well - as is evidenced by the continued growth.... weakness in Cisco's competitors will mean more opportunity for Cisco (FDRY's hic-cup could mean a windfall for Cisco and most important brick and mortar companies will not want to go to a start-up or small vendor in a period of uncertainty... this will only help Cisco when competing for customers). Underlying all this is a strong case that valuations are well in line with where they should be and that folks - after this past year - will be happy to buy into leaders that have strong market positions, consistent earnings, and an a good chance to outperform the indexes going forward. OG

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