Jeremy Siegel's Big Score
Brian Trumbore
President/Editor, StocksandNews.com

I was cleaning out some files the other day when I came across Professor Jeremy Siegel's historic Wall Street Journal op-ed from March 14, 2000. I've referred to it before in prior "Wall Street History" pieces, as well as my "Week in Review" column when he first wrote it, but I thought I'd take another look given the current market environment.

Recall that on March 10, 2000, a Friday, the Nasdaq closed at its all-time high of 5048. The following Monday the index declined 2.8% to 4907 and on Tuesday morning, March 14, traders and investors were greeted by Siegel's piece.

"Big-Cap Tech Stocks Are a Sucker Bet"

"Until yesterday's sell-off the Nasdaq Stock Market had enjoyed quite a run, surpassing 5000 for the first time even as the Dow Jones Industrial Average went through a correction. [Ed. the Dow had topped out two months earlier.] But are the high valuations of the tech stocks that drive the Nasdaq index justified? History suggests not.

"In the late 1960s Polaroid was at the top of its game, dominating the photographic field and enjoying one marketing success after another. Investors bid the stock up to an unheard-of 95 times earnings. Never before had a large-capitalization stock been priced so high. But Polaroid's earnings growth had exceeded 40% a year over the previous 14 years, and the future seemed even brighter.

"IBM became the most valued stock in the world in 1967 and held on to that position for more than six years. The dominant computer manufacturer enjoyed enviable margins and virtually no competition. Its stock value reached 50 times earnings, a striking multiple for the world's largest company. But why not? IBM had regularly cranked out 20% annual increases in earnings from the early 1950s, and the future obviously belonged to technology.

"Yet investors who purchased these and many other stocks when the future looked brightest had much to regret. Polaroid faltered badly, and its stock gave investors 'negative' total return over the next 30 years. And despite IBM's comeback under CEO Lou Gertsner, the company's return has been less than half that of the Standard & Poor's 500 index over the past generation.

"These examples are typical. History has shown that whenever companies, no matter how great, get priced above 50 to 60 times earnings, buyer beware. A few stocks of the nifty-50 era subsequently outperformed the market, but in that venerated group no stock that sold above a 50 price-to-earnings ratio was able to match the S&P 500 over the next quarter century. Such great companies as Baxter Labs, Disney, McDonald's, Johnson & Johnson, AMP and Texas Instruments have trailed the averages.

"But many of today's investors are unfazed by history - and by the failure of any large-cap stock ever to justify, by its subsequent record, a P/E ratio anywhere near 100. As the chart nearby shows, of the 33 stocks (18 tech and 15 nontech) that have a capitalization over $85 billion today, an incredible nine currently have P/E ratios in excess of 100, and six of those are in the top 20.

"Supporters of these valuations point to their fantastic growth and rosy prospects. And indeed, analysts' estimates of future earnings growth?have predicted that these stocks' earnings per share will grow more than twice as quickly over the next five years as the S&P 500.

"But once a firm reaches big-cap status - ranked in the top 50 by market value - its ability to generate long-term double-digit earnings growth slows dramatically."

Professor Siegel later concludes:

"What does all this mean? Our bifurcated market has been driven to an extreme not justified by any history. The excitement generated by the technology and communications revolution is fully justified, and there is no question that the firms leading the way are superior enterprises. But this doesn't automatically translate into increased shareholder values.

"Value comes from the ability to sell above cost, not from sales. If sales alone created value, General Motors would be the world's most valuable corporation. In a competitive economy, no profitable firm will go unchallenged. Margins must erode as others chase the profits that seem so easy to come by now. There is a limit to the value of any asset, however promising. Despite our buoyant view of the future, this is no time for investors to discard the lessons of the past."

Siegel had a chart with various statistics as of 3/7/00. For example, Cisco Systems' market cap then was $452 billion. Today it is $162 billion.

And check out some of the P/Es, based on trailing 12 months earnings, for these companies back in the spring of 2000.

Cisco?148
Oracle?152
Sun Microsystems?119
EMC?115
JDS Uniphase?668
Qualcom?166
Yahoo!...623

I went back, using Yahoo Finance, to check out the share prices of various issues cited by Professor Siegel in his op-ed and it's yet another trip down memory lane.

3/10/00?the day of the top in Nasdaq

Cisco?$136
Oracle?$81
EMC?$130
JDSU?$260
Qualcom?$136
Yahoo?$178

Now before you say, 'wait a minute?didn't some of them split?' Yes, but what's funny is that in the case of Cisco, Oracle, EMC and JDSU, for example, the splits occurred within weeks of the top (of course the companies announced them earlier than that). JDSU actually split 2-for-1 the day after Nasdaq peaked. Cisco split a few weeks after.

Underneath my desk blotter, filled with postcards of Pieter Bruegel winter scenes and one of Shea Stadium, I have this piece of scrap paper with some of the all-time highs (split-adjusted) for various tech stocks as well as the day it was achieved. Not all were on or about March 10, 2000, but all occurred in 2000.

Cisco?$82 [3/27/00]?today $27 (2/1/07?rounding off)
EMC?$105 [9/25/00]?$14
Intel?$76 [8/28/00]?$21
Oracle?$46 [9/1/00]?$17
Sun Micro?$65 [9/1/00]?$6.50
JDSU?$153 [3/7/00]?$17
Juniper?$245 [10/16/00]?$18

But back to price / earnings multiples, in Jeremy Siegel's March 2000 op-ed he also looked at the potential P/E for selected tech giants given estimated growth rates from 2000-2005. So keeping in mind his research on stocks with above 50 P/Es, even looking five years into the future you could project:

Cisco?73.9 P/E?today Cisco's P/E is 28
Oracle?91.3
Sun Micro?82.8
EMC?54.0
JDS Uniphase?195.5
Qualcomm?61.8
Yahoo!...122.6

Needless to say it didn't quite work out for the sector like many had planned in those days. But Professor Siegel nailed this whole topic like no other and for this alone he'll be forever remembered by market historians, aside from his other fine work.

But I bet a few of you were reading this and thinking of Google. After the release of its earning for the fourth quarter 2006, as I write Google's P/E based on 12 months trailing is about 50 and the latest estimate for earnings for 2007 is over $14 and headed higher, I imagine. Ergo, trading at $500 you can do the math. It doesn't necessarily fit Siegel's model, though I hasten to add I am not offering an opinion on Google's shares myself. I'll continue to reserve any such comments for my "Week in Review" column.

*Follow-up: For those of you who follow the "January Effect" and read my annual piece on it a few weeks back, the S&P 500 did finish the month up 1.4%, with the Dow Jones up 1.3%. So if you believe in the adage "As January goes, so goes the year," you can take heart in this.

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Back next week when I attempt to tackle the global fish issue.

Brian Trumbore

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