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August 1, 2000
Rat's Broadband Bandwagon
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Re: Too Many...Too Few...?
I'm not trying to say the sky is falling, just learning like the rest of us. I've been more of an observer rather than an active investor this year. One thing I noticed in my observations was the huge change in price/earnings multiples during the last 2 years relative to historical averages. Just look at the price/earnings ratios for Cisco, Intel and Microsoft during their tremendous gains of the 90's. All three were consistently in the 40-70 range until 1998. Now I know there are many out there that think P/E is meaningless, but I think the trend means something. If P/E's are trending along in the 40-70 range for fast growing companies like CSCO, INTC, and MSFT but then take a significant leap during 1998, I have to wonder. Is that divergence between price and earnings sustainable? It never has been in the past, so why should it be now? I don't know the answer to that question, and it bothers me a great deal.Not to worry, surfcr8z. I probably subscribe to the same 'conservative' investment newsletters as you do and have always read them because I want to know the 'full story'. One that comes to mind which I've skimmed over the years comes from Stephen Leeb and his collection of writers. I pick this one because it was in my lap as I got my haircut today. We can't discredit the fact that the S&P P/E ratios have tripled from their historic lows in the early 80's to historic highs hit earlier this year before the correction. Energy prices, bond yields, inflation, interest rates - all worthy of study for the entire period of 1980 to 2000.
The three stocks you mention above do not have the same growth rates. Cisco handily tops Intel and Microsoft and has for the past couple of years in terms of growth. Let's take a look at some of the multiples for these three.
Trailing 12 months Price to Earnings Ratios:
Cisco - TTM P/E of 183.51
Intel - TTM P/E of 59.74
Microsoft - TTM P/E of 41.51
Revenue growth for the latest quarter y/y growth:
Cisco - 55%
Intel - 23%
Microsoft - 1%
Take the time to read all the above links which runs you through the Rule Maker criteria. If you dig through the archives, you can read how some youngsters are doing in the criteria area like Brocade, Siebel, Broadcom and take news of note that i2 and Siebel both passed all criteria for the first time with this latest quarter.
Regardless, the P/E's of the big three above reflect many things within the metrics, the growth rate and of course, Microsoft's gorillaness being contracted and all the woes around it having an effect on their P/E. Take a look at that growth rate MSFT had for the latest quarter. Wow!
The rest of this post is not for surfcr8z, it's for all of us - including me.
On the other hand, Leeb - who I referenced above - has chosen 7 companies based on their P/E ratios for investment. These 7 companies have roughly the same P/E ratio today that they had 15 years ago.
AutoZone, Burlington Res., Honeywell, Masco, Pall, Texaco and Wachovia. Average P/E is 13.3
If you ran these companies through the Rule Maker criteria - not a one of them would pass. If you took a look at operating cash flow, Foolish Flow ratio, gross margins, net margins, Cash King Margin, cash-to-debt ratios and revenue growth a glaring trend would start to jump out at you as you research the underlying business numbers of these companies that would quickly explain why their P/E ratios are what they are. So I take all of the P/E ratio and historical comparison with a big grain of investment research salt. How many times have we heard in the written media and the television media 'you have to dig down below the top tier names to get to the real value'? That's my favorite line which always causes my voice to emit an uncontrolled "Ha!" no matter where I am. I've emitted a lot of "Ha's!" over the years. What exactly is value? Is Cisco? Is Yahoo!? Is Brocade? Is Broadcom? Is i2? Is Ariba? Is Intel? Is JDS Uniphase? Is Qualcomm? Is Cree? Is Sycamore? Is Redback? Is Texaco? Is Honeywell? Is IBM? Is Disney? Is Citrix? Is AutoZone?
The best performing companies that are printing cash deserve the greatest premiums. You all know my attraction to the gorillas and dominant companies in technology. Find me a basket of non technology stocks that put up the type of numbers that Cisco puts up.
Michael Jordan got a premium. Now Tiger Woods has a chance at a $60 Million year for his premium. Multiple 'Golden Glove Award' winner J.T. Snow gets a premium for his glove filled with glue. (Sorry I'm not more up to date on my sports analogies, I've been overseas for too many years.)
Should Cisco, Intel, Broadcom, Brocade, Siebel, i2, Oracle and others be trading for a P/E of 40 or below? Should Honeywell, Texaco, General Motors, Wachovia be trading for a P/E lower than they are?
In Cisco's case, the stock market wants a gorilla. Microsoft is out of favor and they are not performing so well. I believe Geoff Moore called them a 'contained' gorilla of something to that effect on the GG listserv digest. Don't quote me on that, because I haven't looked it up, but something to the effect that the CAP for MSFT is contained or constrained or one of those words. Some strategical moves that they missed with the Internet have shifted the gorilla focus to Oracle, Cisco and the royalty play of Sun. All three of these companies did not 'miss' the Internet. So, we have seen the market 'latch on to them' because they want and need strong leaders. This pushes the P/E ratios higher and the market is awarding them a huge gorilla CAP and GAP because of it.
When discussing the young companies with revenue growth y/y of 100 to 500%, I'm not even looking at P/E's. If Texaco was growing their revenues at 350% y/y, believe me - the market would take notice and up the value of the share price. Back to my comments on the Stephen Leeb selection of those 7 stocks. Not once in his newsletter does he get beyond the P/E ratio and talk about the kinds of important metrics that a Rule Maker criteria talks about. No mention of margins. No mention of y/y revenue growth or sequential quarterly revenue growth. No mention of debt. No mention of cash flow. Nada, nada, nada, nada!
I will turn the other side of the coin and support some of Leeb's high-quality growth names he has in his portfolio like Intel, Pfizer, General Electric and.....well that's about it.
We can all go through a variety of sources from Tice and Fleckenstein to the big mutual fund quarterly updates to magazine articles to the usual 'wise' that appear on CNBC and find holes ten miles wide in their thoughts and theories. That doesn't say I don't have concerns or have not had concerns along the way in the past 20+ years. However, it is to say that assembling a team of investments for my portfolios requires a lot more information than the typical newsletter, wise 'guru' or periodical article will ever mention. I hate to say that I'm proud to be a Fool, but I am. If you haven't read David and Tom's books. If you haven't taken part in one of the online seminars. If you haven't been combing over the balance sheets for the stocks that you own. If you haven't been rolling up your sleeves and seeing what is under the hood of every investment you own. Then I fear that the attraction of investing will be lost and surrounded by too much floundering for long term success.
Take the time to become a Fool. Cisco's underlying fundamental metrics are not the same in 2000 as they were in 1993 or 1995 or 1998. Intel's underlying numbers are not the same in 2000 as they were in 1980 or 1985 or 1990. These companies are smokin' ! If Intel had the type of numbers they have now in 1980 or 1985, believe me - everyone would have been there. Study how the metrics have improved. There is a wealth of information as to why these companies carry the market multiples that they do.
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