What to Make of ‘Old Tech’ with a Spotlight on Cisco?

We call these names ‘Old Tech’.

What is going on here?  How can one, especially myself, explain such a wide variance between the stock prices and our calculation of model price or our so-called ‘fair market value’?

Yes, I’m getting ahead of myself.

We (at Acker Finley) can do sorts on our Model Price database.  Let me share with you a sort I did this past weekend.  The output (below) is the results of ranking the most upside to our calculation of model price in the S&P 100 – outlined in red.  The S&P 100 population being the largest capitalized companies in the S&P 500.

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The top 4 names, with the biggest differential, are Cisco Systems (CSCO), Intel Corporation (INTC), Oracle Corp. (ORCL) and Microsoft Corporation (MSFT).  Yes, we call these names ‘Old Tech’ because they have been around for a while, since the late 1980’s, and everyone seems to know whom you are referring to when you mention this colloquialism.

Or maybe we call this group ‘Old Tech’ for a reason.  Larry Ellison of Oracle Corp. is now 69.  Bill Gates of Microsoft is 58.  Cisco’s CEO, John Chambers, who seems to me to be around forever and is currently 64.  Intel just changed CEO’s bringing in Brian Krzanich at 53.  The tech stocks that currently seem to be working in this market; Facebook, Yahoo and Google have Mark (Zuckerburg) 29, Marissa (Mayer) 38 and Larry (Page) 40, respectively.

Coincidence, maybe!

Having fun with some numbers, these four companies represent $728 billion in market value, certainly not an inconsequential number.  If these 4 companies were trading at our calculated model prices – fair market values – the market value increase would be over $350 billion dollars.  Yes, a staggering amount of latent wealth not in use in the global economy.  Undiscovered potential wealth that would help underfunded corporate pensions, individuals retire sooner with more robust 401K plans, and US Federal Government fiscal revenues with substantial increases in capital gains taxes.

Who is the blame for this differential?

Equity markets give valuation to those companies that are growing, both top line revenues and profits.  These 4 tech behemoths are profitable however their fastest growth years are certainly in the rear view mirror.  New technology entrants are inventing and growing in new market categories – taking the spotlight and buzz that these companies once had.

Each of these 4 companies started as minnows that became whales.  As Bill Gates pointed out in a recent interview with Charlie Rose for every 1,000-technology company startups, 999 fail.  And the CEO’s who won this start up lottery are paranoid, egotistical, and are sitting on stockpiles of cash.  Yes, way too much cash for each of their companies to use efficiently but they have a good excuse… the US Federal Government.

Much, if not all, of this cash pile these 4 companies hold is held in offshore accounts.  If any these 4 companies and others repatriated these funds from abroad they would be subject to a 35-38% corporate tax rate, one of the highest in the world.  So you guessed it, a Mexican standoff, where the US Federal Government hungry for tax revenue sees a day when these foreign monies migrate home to the US over time and US Multinational Companies, including the 4 mentioned, lobby for a tax holiday on their foreign profits.  Stupid I know, but this is America in 2014.

Focusing on Cisco Systems

Cisco System reported their second quarter earnings this past week so I decided to do some extended model price homework on the company when I saw the eye popping 60% upside from the close on Friday, February 14th, 2014 to our calculated model price.

Cisco Systems Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Cisco Systems Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

As some of you come to expect on ModelPrice Guy blog, below is our unique chart showing our calculated Theoretical Earnings (TE) along with Cisco’s 12-month EPS forecast on a semi log scale.

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For those not familiar with our calculation of Theoretical Earnings (TE) see under – Key Concepts Tab – above.

For ease of analysis we chart the two variables (above) as a ratio.

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As you can observe Cisco’s earnings have clearly stalled over the last 5 years.  With stalling earnings and an ever-increasing Theoretical Earnings (TE) the ratio between these two variables is getting squeezed.

Here is our long-term chart of CSCO over the last 7 years.  Observers can see the valuation of the company being reduced by the market as earnings stagnate and our ratio between earnings and TE is slowly getting pinched.

Cisco Systems Inc. with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Cisco Systems Inc. with monthly price bars, EBV Lines (colored lines) and model price (dashed line)

Conclusion

1.  The upside potential in CSCO is great – a potential 60% return.  This is why investors should consider a portfolio of stocks.  Place CSCO in a portfolio of stocks, with our calculated upside and who knows what will happen.  Simply stated, CSCO will have their day ‘in the sun’, I just don’t know when.

2.  What is the downside to owning CSCO?  Not much – certainly potential of outperformance in a down market.  So if the equity market corrects or better still investors wake up one morning and decide NOT to ‘pay up’ – valuation wise – for the growth stories of the day, investors could always rotate back into ‘Old Tech’ from ‘New Tech’ if valuations between these two groups get stretched giving value investors potential significant market over performance.

3.  Nature and public companies ‘abhor a vacuum’.  Shareholders are getting increasingly restless and not only want some their cash back – locked away in these companies and others (Apple, for example) – but also want growth, both in top and bottom lines.  If and when this ‘Mexican standoff’ ends between multinational corporations and the US Federal Government these huge cash stockpiles can be tax efficiently distributed, thereby increasing valuation – by lowering our Theoretical Earnings (TE) calculation – and help grow the global economy – mobilizing latent capital and increasing its velocity.  Yes, everybody wins.

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