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Technology Stocks : Cisco Systems, Inc. (CSCO) -- Ignore unavailable to you. Want to Upgrade?

To: Kashish King who wrote (33230)	4/1/2000 8:45:00 AM
From: John Malloy	Read Replies (3) \| Respond to of 77400

I own a bundle of Cisco. Like Rod Macpherson, I am also worried that Cisco may be way overvalued, and that it may be time to sell. Rod is concerned because the P/E is near 200; he thinks it should be closer to 30. Rather than worry about what P/E is appropriate for a stock that is growing as fast as Cisco, I prefer to calculate by discounted cash flow the most I can afford to pay for Cisco and still earn some minimum after-tax return. Cisco's value depends on how fast you forecast equity/share will grow and the price/book ratio will fall. I forecast by drawing free-hand curves on a sheet of graph paper. Free-hand curves give me the maximum flexibility in forecasting how growth and the P/B ratio might change in the future. Cisco's equity/share is now growing 46 %/yr. and the P/B ratio is at a sky high 31.4. Certainly Cisco cannot maintain such rapid growth and high P/B ratio forever. Eventually they must both come down. I have been exploring how rapidly the growth rate would have to slow and the P/B drop before Cisco costs too much. I find it would take drastic declines in both before Cisco costs too much at today's price. Equity/share is currently growing 46 %/yr. I have growth slowing to 43.1 %/yr. in one year, 36.1 in two, 30.4 in three, 27.5 in four, and 25.5 %/yr. in five years. As growth slows, investors will no longer pay such high P/B ratios. Along with slowing growth, I have the P/B ratio falling from 31.4 now to 26.2 in one year,18.3 in two, 15.3 in three, 13.8 in four, and 12.6 in five years. That combination of growth and P/B ratio leads to stock prices of $101 in one year, $105 in two, $123 in three, $149 in four, and $179 in five years. The falling P/B ratio largely offsets the growing equity/share and causes the slow growth in price. The most I can afford to pay for Cisco depends on the minimum after-tax return I insist on, and on how long I plan to hold the stock. If I insist on a 15% after-tax return and plan to hold the stock one year, I can afford to pay $79 -- near Cisco's current price. The longer I plan to hold Cisco, the less I can afford to pay. If I planned to hold Cisco for five years, I could only afford to pay $64. I can afford to pay more if I lower my minimum after-tax return standard from 15 to 12%. I can afford to pay $82 if I hold the stock one year, but only $72 if I planned to hold Cisco two years. If you accept my growth and P/B forecast, Cisco is not wildly overvalued. But it is not a great bargain, either. Based on what are probably pessimistic forecasts, Cisco today is fairly priced. John Malloy