Treasury Yields Are Coming For Tech
The theme of the past decade in tech stocks was perpetual growth. But here’s a question no one ever asked: Is infinite growth sustainable?
I personally believe when absurd growth expectations get priced into things like stocks, houses, etc…..the risk/reward decreases dramatically. You want to buy in when things are hated, not when everyone loves them.
This doesn’t mean the companies themselves won’t be successful; it just means the current stock valuation has a lot more downside than upside left.
Cisco—A Textbook Example
During the dot com bubble Cisco was killing it; At the turn of the new millennium, the IT hardware, software and networking equipment company was one of the hottest stocks in the US equity market.
From the beginning of 1999 to March 2000 the shares rose 236% to a market capitalization of $555bn, or $80.06 per share, backed by a crazed-enthusiasm for the technological shifts bought about by the internet.
The thesis was solid: as a provider of networking equipment for both telecom players and other businesses, Cisco was the shovel-seller in a dot com gold rush. What could go wrong?
It even had the numbers to back it up. In the 2000 financial year, Cisco posted revenue growth of 55 per cent, gross margins of 66 per cent and had a return-on-equity of 14 per cent.
It was one of the few players sitting at the intersection of several technological trends, surely it was going to be one of the winners of the new millennium…..right?
Well… yes and no. In one way, investors were right. Cisco was a big winner. Over the next 21 years, Cisco’s revenues grew four fold to $49bn, with profits quintupling to $11bn.
The problem was the share price. It was just too high. At the March 2000 peak, Cisco’s price-to-earnings ratio stood at 201 times, its enterprise value to sales at 31 times and its price-to-free cash flow at 176 times. Over the next two years, Cisco’s share price collapsed 80 per cent, a total market capitalization loss of $431bn, as the dot com bubble deflated.
TWENTY TWO years later, as of now (Feb 2022), Cisco currently sits $54/share, sitting -32% below its peak in the year 2000.
Investors betting on expensive tech stocks today, whether it be Tesla or Facebook, will do well to heed the lesson of 2000: Era-defining businesses, at the wrong price, make for terrible investments.