The S&P 500 and Cisco: A Historical Perspective

 

Early in the year 2000, and late in the dotcom-bubble era, the stock of Cisco (CSCO), a company that provides internet hardware and software for the secure transmission of voice, data and video, traded briefly at a price of $80 U. S.  The company had reported net profit per share of $.62 for the year ended July 31, 1999, valuing the stock at 129 times earnings (the “price/earnings multiple”).  The market capitalization of Cisco stood at $272 billion, or 22 times fiscal year-end sales of $12 billion.      

 

Two recent research reports implicitly provide some perspective on not only Cisco’s stock valuation in early 2000 and that of today, but also on today’s stock market.  While Cisco’s stock was raging ahead in 1999, on its way to an all-time high, the market in the U. S. as measured by the S&P 500 hit a record of just over 2.2 times sales.  Fast forward 20 years with the July 24th issue of The Globe and Mail referencing a recent report of Citgroup’s Tobias Levkovich.  He examines the implications of a price to sales ratio that bounced even higher in January of this year than that recorded in early 2000, albeit fleetingly and by the slimmest of margins.  Levkovich plots the price to sales ratios of stocks in the S&P 500 going back thirty years and then takes a look at the subsequent 5-year stock-market returns.  Essentially, he found that the higher the price to sales ratio for stocks, the less impressive the forward 5-year rate of return for the S&P 500.   

 

With his July 22, 2020 report entitled “Macro Musings,” Myles Zyblock of Dynamic Funds takes a different approach to valuing stocks by basing his analysis on earnings.  He states that the market, measured by the S&P 500, “is not cheap” at 23 times earnings (the P/E ratio) since that level of pricing places it in the 91st percentile going back to the 1950s.  However, as he points out, “an expensive stock index does not necessarily mean an expensive market of stocks.”  The top 50 stocks in the S&P 500, which are currently driving most of the market performance, are valued at almost 27 times earnings, while the bottom 100 are priced at just less than 14 times. He carries the valuation method further, based on priced to sales, price to free cash flow and price to book value, with similar results:  the top 50 stocks show considerably higher valuations to the balance of 450 companies.  In essence he is hitting on the “value” vs. “growth” theme, suggesting that perhaps some bargains are “hiding” in the bottom 100.  While we accept the fact that there may be reasons that some stocks are expensive and some are very cheap, we also feel that many of the lesser valued stocks of today can offer significant long-term upside.  Zyblock concludes, in part:

 

Today’s index metrics are disproportionately influenced by the characteristics of the mega-cap stocks. For the value in many of these less expensive stocks to be unlocked, we will probably need to see the signs of a more reliable recovery taking hold.

 

Back to Cisco, priced at $46.45 U. S. (July 29), which trades at 14.7 times expected July 31st earnings of $3.15 and sports a market capitalization of $195 billion U. S., or about 4 times sales.  The stock provides a dividend yield of 3.1%.  We like the company’s prospects as it moves to less reliance on communications hardware in favour of Software as a Service (SaaS) in cloud computing and other areas of business while expanding on its expertise in internet security. And the investor is not paying a huge multiple of earnings in the process.