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The Rise and Fall of Cisco
A sad story of over-valuation that is especially relevant today
In the first season of True Detective, a bedraggled Rust Cohle says:
“Time is a flat circle. Everything we’ve ever done or will do, we’re gonna do over and over and over again.”
So, too, for the stock market.
Every so often, a belief seizes the investment crowd that valuations don’t matter anymore. That anyone can buy a growing company at any price and everything will work out just fine. That trees really will grow to the sky.
Investors pile into hype stocks at nose-bleed valuations on the faintest hint of future growth. Often, it only takes a popular concept — like EVs or cannabis — to attract inordinate attention and investment without any accompanying revenue or profits.
This never ends well.
But no one seems to remember that part…
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Back before the dot-com bubble burst, Cisco was the stock.
The company brought internet networking (through switches and routers) to the masses just as the entire world took its first tentative steps into cyberspace. If it happened online in the 1990s, Cisco had a hand in it.
$CSCO delivered 100% annual returns in the ten years after its 1990 IPO, boosting the stock from a split-adjusted price of $0.08 per share to a high of $80. That blistering growth catapulted it to the top of every speculator’s list and even led some experts to tip Cisco to become the world’s first trillion dollar company.
Bullish doesn’t even begin to describe it.
When Cisco reached $80 on March 27, 2000, it officially became the most valuable company in the world with a market cap of $569 billion. But, with just $0.36 of net income per share, Cisco traded at 220x earnings.
An insane valuation for any company, let alone a large-cap one.
For Cisco to grow fast enough to justify such a multiple, it would need to soon rival the size of the American economy as a whole.
In a word — impossible.
Through it all, a rogues gallery of analysts egged on euphoric investors. In fact, some even admitted that their recommendations and price targets were less the result of expert analysis and more about telling the crowd what it wanted to hear.
“We have to accept the facts of life,” said one from Morgan Stanley Dean Witter. “If investors want to be in these high-growth companies, we are just trying to take what they’re willing to pay and translating it into a target price and, therefore, a stock recommendation.”
“If you had picked a price point to sell at any time in the past ten years, you would have been wrong,” echoed another from Chase Hambrecht & Quist. “[Cisco] has such an impressive track record of growing … that the financial community isn’t thinking in terms of a multiple of what they’re earning this year, but what they will be earning three or four years down the line.”
Top prize in this carnival of stupidity, though, goes to this PaineWebber analyst. “At 28% growth, Cisco is probably worth 150 to 175 times earnings.”
If you ever catch me saying a company is worth 175x earnings, feel free to shoot me.
It took someone like Dr. Jeremy Siegel to point out that this emperor had no clothes.
The Wharton professor (and author of Stocks for the Long Run) studied large-cap companies with huge earnings multiples and came away thoroughly unimpressed.
“History has shown that whenever companies, no matter how great, get priced above 50 to 60 times earnings, buyer beware.”
He was right.
This time was not different.
Not even for Cisco.
After reaching that $80 high in late March 2000, Cisco started to drop. Fast.
And, within one year, it had lost 85% of its value.
This was not a dying business. No fraud or accounting irregularities. The need for internet networking (obviously) did not disappear.
The company’s growth just slowed down. That’s all it took.
As Dr. Siegel said, great companies are not exempt from the perils of over-valuation. And, when that over-valuation involves an earnings multiple of 220, the reckoning will be devastatingly severe.
Despite growing revenue from $19 billion in 2000 to nearly $50 billion in 2021, Cisco’s stock has never fully recovered. For most of the past two decades, $CSCO traded between $15-30 per share and only recently pushed its way back into the $50 range. A far cry from those heady $80 days at the turn of the millennium.
Pity anyone who trusted the experts back then and bought the unstoppable Cisco at the height of its popularity. At best, they’ve clawed back a little more than half of what was lost in 2000 and 2001.
A lot of money went up in smoke because people desperately wanted to believe that valuations didn’t matter anymore.
Like most cautionary tales, the rise and fall of Cisco has been largely forgotten by investors. They pay lip service to the importance of avoiding over-valued stocks and then proceed to YOLO all of their money into companies like Tesla.
(Nothing personal, Elon. I’m a big fan. Your stock is just too pricey right now.)
The allure of manic hype and unending growth remains undefeated. If there’s one lesson to learn from Cisco, it’s that following the crowd is rarely the right choice. Don’t follow them down the primrose path.
Cisco shareholders have been paying the price of their over-exuberance for twenty years now. And, based on the recent popularity of Tesla or the ARK Innovation Fund, it seems that investors have learned very little.
Rust was right. Time is a flat circle.
Disclosure: This is not financial advice. I am not a financial advisor. Do your own research before making any investment decisions.