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Confessions of a Money Manager: There are bargains on Wall Street
Well, it's now official. The Dow Jones Industrial Average is now down 20 percent from its high of last October. That's the technician's definition of a bear market. That leaves us with the question: "Is this just the beginning of another 2000-2002 debacle?" Only time will tell, but given today's low stock valuations relative to 1999, that seems unlikely. Of course, all bets are off if the planet explodes because of global warming.
So just how low are stock valuations? I could drone on with confusing stock market metrics, but such statistical blathering doesn't put a real face on the issue. Instead, let's take a look at one of the market's favorite growth stocks, Cisco Systems (CSCO $22.74), and check its progress since 1999.
Cisco was one of those technology darlings during the roaring 1990s. Its stock shot up to almost $80 at the peak of the bull market in March 2000. Those who remember back then will say it was actually much higher, but I've adjusted the price for the 2-for-1 stock split that occurred that very month. Stock prices, however, are meaningless unless you compare them to earnings. Back then Cisco was on track to report earnings of 36 cents per share for the fiscal year that ended on July 31, 2000. Comparing the stock price to the earnings -- conventionally known at the price-to-earnings ratio or P/E -- the stock was selling at 200 times its earnings!
To say the least, this P/E ratio was in the stratosphere. With hindsight we know that that price had to come down. And it did. By September 2002, the bottom of the 2000-02 bear market, Cisco's stock fell below $10 a share, a decline of more than 85 percent. Obviously, the bubble burst on Cisco. But did Cisco bust? Hardly.
The ensuing recession -- or should I say depression -- in techland was devastating. More than 1,600 publicly traded, tech-oriented companies went bankrupt. And Cisco wasn't immune to the downturn. In 2001 it suffered its first loss when sales growth slowed, and the company reported a loss. Cisco's management, however, prepared for the worst. In 2002, year-over-year sales actually declined to $18.9 billion from $22.3 billion the year before, but the belt-tightening enabled the company to show a profit of 25 cents a share.
When the tech economy started to recover in 2003, Cisco's sales stayed flat at $18.9 billion, but earnings rose to a record 50 cents a share. By 2004, Cisco's sales started to grow again and earnings marched ahead as well. In 2005, 2006, and 2007, Cisco's sales and earnings hit yearly highs, and for their fiscal year ending this coming July 31, analysts are projecting sales of just over $39 billion and earnings of $1.50 a share. For 2009, sales and earnings are projected to hit $43 billion and $1.70, respectively.
So what do we value Cisco's stock at? Using that same P/E formula we used in 1999 ndsh stock price divided by earnings per share -- we find Cisco's stock selling at just 15.2 times earnings ($22.74 divided by $1.50). Do I own this stock personally? You bet I do. And I'm going to buy more.
Do you think we're going to have a repeat of the 2000-2002 bear market? If that happened, Cisco's stock would have to fall to roughly $5 a share to match the decline it suffered from 1999 to 2002. I doubt that will happen since Cisco currently has $4.14 of cash per share on its books.
We can all find reasons why the stock market is weak: record oil prices, the housing bust, bedlam in the banking sector, you name it. We read it and see it every day in the news. But before we have a death spiral in the stock market, we need a high platform to spiral from. You can't bust a bubble until you inflate a bubble. From 1995 to 1999, the S&P 500 gained an average of 28 percent a year. Corporate earnings didn't come close to matching that growth rate, so air was being blown into the valuation bubble.
Is there a bubble today? Hardly. Over the last four and a half years -- after the initial bounce back in 2003 when the S&P 500 jumped 26.8 percent -- the market has averaged a paltry 5.4 percent.
If a clothing store offered high quality suits at a 20 percent discount, we would jump at the opportunity. Today, Wall Street's having a Fourth of July sale, and stocks like Cisco are selling at bargain prices.
Cisco Systems
Shares of Cisco Systems are selling for a bargain rate right now on Wall Street.
