Here's a post from CSCO thread (hope he doesn't mind me reproducing) on a book predicting continued soaring bullmarket, & saying CSCO undervalued:
For those that have the time interesting reading on DOW 36,000 from a soon to be published book. CSCO is used as an example to show how undervalued it is at this time. To really understand what the authors are getting at you need to read the whole article, three parts total. The extract that I have cut below is from part 3. For those of us that believe the new economy is relevant, that the tulip and madness of crowd crew are jealous because their old models just are not cutting it, then this article and book are a breath of fresh air. People continue to work on finding better approaches to explain what is happening in the markets. For those that believe, understand or recognize the profound changes coming, the future is bright indeed.
Has the long-running bull market been a contemporary version of tulipmania? In explaining their new theory of stock valuation, the authors argue that in fact stock prices are much too low and are destined to rise dramatically in the coming years
by James K. Glassman and Kevin A. Hassett
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The reported earnings of most companies, very clearly, are greater than the cash that flows into your pocket over the time you own a stock. But just as clearly, quarterly dividends are less than that cash flow. After all, many of today's greatest success stories -- Microsoft, Amgen, Dell Computer, to name a few -- do not pay conventional dividends at all. Yet their stock prices have risen sharply -- a sign that investors believe that they will see cash in the future.
Is there any way we can value a company when all we have is reported earnings?
Actually, there are several. One way is to use the two stages we introduced earlier -- adolescence and adulthood --but with a subtle change. Assume that during adolescence, as a company pours its earnings back into the firm rather than handing them out to shareholders as dividends, the company will increase its earnings at a high rate. At maturity the firm will start paying dividends, and will increase them at a low rate. Back before tax considerations became an important determinant of payouts, mature firms paid out about 70 percent of earnings as dividends, so we will use that figure. Let's see how much cash can be expected to go into your pocket if you put your money in a popular firm, Cisco Systems <http://www.netsystech.com/>, that had very high P/Es last spring but that doesn't pay dividends.
Founded in 1984 by a small group including Leonard Bosack and Sandra Lerner, a husband-wife team from Stanford University, who mortgaged their house to raise money and built prototypes in their garage, Cisco Systems has become the largest manufacturer of networking products in the world. Specifically, Cisco controls 85 percent of the market for switches and routers. It also makes the dial-up servers that give computer users access to the Internet.
Cisco's sales rose from $27.7 million in 1989 to $8.5 billion in 1998. Over those ten years Cisco increased its earnings by an annual average of 115 percent. Growth has slowed recently, but not much. Over the five years ending in 1998 average annual earnings increases were 59 percent. The company has a fabulous balance sheet, with no debt, $1.7 billion in cash and marketable securities, and another $1.3 billion in notes due from others. Cisco puts much of its profits back into the business, but not all.
Last June, Cisco was selling at $64, and with earnings per share of 74 cents had a P/E of 86. Pretty expensive stock? Not really. If Cisco's earnings increase at the same rate over the next five years as they have over the past five, they will increase by a factor of 10, to about $7.50 a share. Suppose that Cisco's price doubles over that five years. Its P/E at that time will be 17 -- hardly outrageous.
Now suppose that Cisco has five years of adolescence and then, hitting maturity, starts paying 70 percent of earnings out as dividends. Let's use our assumption that dividends per share will grow at about 0.5 percent below the GDP growth rate after the firm reaches maturity.
Using the standard formula for calculating a stock's present value according to the flow of cash it generates over time, we find that Cisco's PRP should be $399 a share. In other words, Cisco's price last June would need to sextuple. Its P/E would rise to 539 (no, that's not a misprint).
But even with the Internet boom, it may be stretching credulity to project a 59 percent growth rate for Cisco. Value Line's analysts project a 25.5 percent growth in earnings for the company over the next five years, so let's use that figure -- and again assume that when adolescence ends, dividend payouts of 70 percent of earnings will begin, with dividends growing slightly more slowly than the U.S. economy. In that case, with a five-year adolescence the PRP for Cisco should be $122, for a P/E of 165. If growth continues at 25.5 percent for ten years, the PRP is $291 (about five times this year's price for the stock), and if it continues for twenty years, $1,652.
The point is that at its current levels Cisco is not an overvalued stock. Whether it should rise by a factor of two or by a factor of 30 to reach its PRP depends on your assumptions. We think a factor of four or five is reasonable.
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<http://www.theatlantic.com/cgi-bin/o/issues/99sep/9909dow.htm>
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