Jacob,
Cisco is the major player in a high-growth market. The current downturn is likely to be temporary. Growth should recover, although not to the level that existed before the downturn.
Based on that scenario, here is my formula for Cisco’s future price. Forecast the price/book ratio and how fast equity/share will grow. Then multiply the equity/share that results from the growth forecast by the price/book forecast.
Growth in equity/share had been falling steadily, from 60%/yr. in the early 1990’s to 45 %/yr. by 1999. Cisco’s customers then cut capital spending, and equity/share grew only 18%/yr. in the last six months. Suppose growth stays that low another six months, then gradually increases as the economy (and Cisco's customers) recover. Suppose growth recovers to 23%/yr a year from now, peaks at 34 %/yr. in three years (well below the 45%/yr. in 1999), then gradually slows to 27%/yr in five years as the industry comes closer to maturity. That growth pattern brings equity/share to $4.77 in one year, $6.23 in two years, and $16.14 in five years.
The price/book ratio had been declining gradually from 18 in 1993 to 13 in 1997. Optimistic investors then pushed the ratio up to an astounding 26 in 1999. The current disaster dropped the price/book ratio to only 6.2. The ratio will recover as growth recovers. Suppose the ratio grows to 8 in one year, peaks at 9.6 in mid-2003, then falls off again as growth slows, and reaches 6.9 in five years.
Those two forecasts lead to a stock price of $38 in one year, $58 in two years, and $110 in five years. An investor who insists on a 15% after-tax return could afford to pay $31 if he planned to hold Cisco one year, $39 if he planned to hold two years, and $44 if he planned to hold five years.
John Malloy |
