Intro Help Topics Retirement Planner Retirement Perspectives Manage Your Retirement

Cisco's Tale Is Fodder For Both Optimists And Pessimists By Stephen J. Butler

Archives

The recent 80 percent plummet of Cisco Systems' shares illustrates two basic principles of investing. First, a falling tide lowers all the ships -- even great ships. Cisco is a splendid company and a marvelous American success story. Yet its stock has undergone severe punishment since hitting its 52-week high of $70.

The second lesson is that diversification -- spreading investments over many companies -- offers a cushion against losses of this magnitude.

I've written about diversification in past columns, so I won't pursue that point right now. The question at hand is whether Cisco will become the poster child for a new paradigm of investment thinking -- or whether it's fated to be a poignant symbol of excess, hype and miscalculation.

The controversial new paradigm is based on the premise that stocks will henceforth be priced higher than their historical levels. That's because investors are now supposedly comfortable with the greater risks that stocks represent compared with bonds.

Investors historically have bid up equity prices to about 15 to 20 times earnings. More recently, P/E ratios have soared higher -- closer to 30 to 40 times earnings. Even in the summer of 2001, after months of declining prices, stocks are averaging 29 times earnings, which is still nosebleed territory by historical standards.

A recent book, "Dow 36,000" by James Glassman and Kevin Hassett, argues that the stock market can continue advancing beyond the boundaries prescribed by the ever-popular "reversion to the norm." If there was ever an investment tome that trumpeted the clarion call of "This time it's different!" then this book is it.

The book's thesis is that a new generation of investors are more sophisticated than our predecessors. We'll tolerate more fluctuations in stock values in the near term because we're confident that, over a long period of time, we'll be well rewarded by our stock holdings.

According to Glassman and Hassett, investors are not insisting that a current stream of earnings be offered at a relatively cheap share price. The new breed is willing to pay more than previous generations. Those old paradigm investors would have blanched, fainted, or gone into cardiac arrest at the thought of buying a dollar of earnings for $40.

The new generation believes that $40 spent today may be purchasing what in five or ten years will be $5 or $10 of earnings. According to the authors, it's the delicious potential for dramatic future gains that throws historical price earnings relationships out of whack.

That brings us to the networking colossus of San Jose. Cisco was founded in 1984 by a Palo Alto couple who borrowed against their home to raise the capital to make some prototypes in their garage. The husband and wife both worked in Stanford's computer sciences department and were trying to figure out a way to communicate with one other by using their personal computers.

A mere 17 years later, the company will gross $26 billion in sales. Cisco's sales to China have gone from $100 million to $1 billion in just a few years, and the same growth is anticipated for India. In the late 1990s, Cisco became a darling of both institutional and individual investors and was briefly the most valuable company in America (as measured by market capitalization), pulling ahead of Microsoft, General Electric and Exxon.

Right now, though, it's raining pretty hard on Cisco's parade. The demand for Internet hardware and telecommunications equipment is depressed. A legion of feisty new competitors is on the attack, salivating at the prospect of biting into Cisco's historically huge profit margins. Cisco has laid off employees and put expansion plans on hold.

Cisco's stock has suffered terribly, as have shareholders who were late arriving at this particular party. Investors need to ask if this will be a long, tormented struggle back to respectability. Remember that RCA needed about forty years to return to its 1929 stock value, when it had a monopoly on the hardware of radio technology. Or will Cisco perform more like resilient Nifty Fifty stocks, which collapsed in the '70s but rebounded to deliver tremendous rewards in the '80s and '90s?

If you buy the more optimistic picture -- namely, that Cisco's current woes only reflect a momentary overstuffing of its product pipeline -- then we might expect its earnings per share to increase again in the near future. With a stock price around $18, Cisco could represent a tremendous value.

It's like the stockbroker who was once asked when would be a good time to buy Microsoft. He responded, "The stock market is open about 210 days of the year, and any one of those days is a good time to buy Microsoft." The authors of "Dow 36,000" would say the same for Cisco.

During times of pervasive market gloom, it's heartening to read books that claim that the stock market is underpriced (Harry Dent's "Roaring 2000's" books are good examples of this genre). Be aware, however, that the rationale underlying these books can be a little suspect, because sooner or later there's a message that you should consider working closely with a broker or advisor. As the author of two books on 401(k) investing, I've had a little exposure to the bookselling business. Appealing to the investment community is a big part of that selling challenge. If your book talks about how great the stock market and stockbrokers can be, then you receive paid invitations to speak to large groups of investors, who, in turn, buy your book.

Even with that caveat, I'd recommend "Dow 36,000." Any investment book that doesn't put us to sleep will improve our comprehension of how different investments can serve our needs. This book's underlying premise is that a buy-and-hold strategy is the best answer to attaining a long-term financial goal. That's a sensible and praiseworthy idea, especially for retirement investors who are building a 401(k) or IRA over many years.

BUYandHOLD does not offer or provide any investment advice or opinion regarding the nature, potential, value, suitability or profitability of any particular security, portfolio of securities, transaction or investment strategy. Any investment decisions you make will be based solely on your evaluation of your financial circumstances, investment objectives, risk tolerance, and liquidity needs. The securities mentioned above are being used for illustrative purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy and past performance is no guarantee of future results.