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Cisco Systems
Where do I stand?

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By ANDROCLES
April 30, 2002

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My friend "BuildMWell" and I have differing points of view regarding the stock market in general and CSCO in particular. He believes that the market is bound to turn around and grow again as robustly as before because history shows that the American economy expands over time and like a rising tide it lifts all boats. He just doesn't know when.

He also believes that CSCO's fortunes are bound to improve because it is "the backbone of the internet...as goes the internet, so goes Cisco." He just doesn't know when.

I believe that the stock market is a trap for the unwary, a risky place where a few (brokerage houses, research analysts, business executives, media hypesters, and miscellaneous con men) get rich at the expense of many. I believe that CSCO is an example of a company that was in the right place at the right time. I believe that the circumstances which led to CSCO's success and that of hundreds of other so-called Internet companies were a once-in-a-lifetime alignment of the cosmos that will never be repeated. In my opinion, all the low-hanging fruit on the Internet tree has been picked and from here on out it will be much riskier for investors to reap the reward that history according to "BuildMWell" promises.

Much has been said here about the power and pervasiveness of the Internet and how that amounts to almost a guarantee of a bright future for those companies with solid financing, proprietary products, effective management, innovative engineering, and brand dominance. CSCO seems to satisfy all of those criteria. But if I am right these criteria won't make the same difference in the future as they have in the past. Why? Because increased competition, especially from all those companies that share a common sense of urgency about their survival (LU, NT, JNPR, etc.) will limit CSCO's ability to grow at historic rates. Price will be a much more important consideration in the future for buyers who themselves face extinction (T, WCOM, QWEST). Plus, the Internet has been oversold by its evangelists. No one knows how long it will take to soak up all the unused capacity currently installed all across the world. It could take many years. In a way, the telecom market is like Georges Bank; it has been over-fished.

In my opinion, CSCO's biggest problem, one that is seldom discussed here, is its huge overhang of 7.3 billion shares, second largest among all U.S. companies. Try to imagine how long it will take for CSCO to earn $1 per share with 7.3 billion shares outstanding. With after-tax profits of 10% (generous in my judgment) it will take $73 billion in sales, or four times this fiscal year's forecasted result. Even with annual compounded rates of growth of 15% (again, generous in my judgment) it will take 10 years. Choose your own P/E ratio to come up with a fair price for the stock 10 years hence. I say 20X is more than fair. Why would anyone want to wait 10 years for a share of CSCO to appreciate from $14 to $20?

That is where I stand, on the side of prudence. I see myself as a pragmatist, not a pessimist. There's a difference. Who ever thought that IBM could be dethroned by upstarts like MSFT, SUNW, and DELL? Out there somewhere is a young, unknown company with a creative product at a better price. That's what CSCO has to worry about. History repeats itself. There are no guarantees. Investing in the stock market may turn out to be a bonanza for you but I don't think CSCO will be the mother lode that delivers the gold. Time will tell.

Andy


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