Wall Street History

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Wall Street History

02/02/2007

Jeremy Siegel's Big Score

I was cleaning out some files the other day when I came across
Professor Jeremy Siegel’s historic Wall Street Journal op-ed
from March 14, 2000. I’ve referred to it before in prior “Wall
Street History” pieces, as well as my “Week in Review” column
when he first wrote it, but I thought I’d take another look given
the current market environment.

Recall that on March 10, 2000, a Friday, the Nasdaq closed at its
all-time high of 5048. The following Monday the index declined
2.8% to 4907 and on Tuesday morning, March 14, traders and
investors were greeted by Siegel’s piece.

“Big-Cap Tech Stocks Are a Sucker Bet”

“Until yesterday’s sell-off the Nasdaq Stock Market had enjoyed
quite a run, surpassing 5000 for the first time even as the Dow
Jones Industrial Average went through a correction. [Ed. the
Dow had topped out two months earlier.] But are the high
valuations of the tech stocks that drive the Nasdaq index
justified? History suggests not.

“In the late 1960s Polaroid was at the top of its game, dominating
the photographic field and enjoying one marketing success after
another. Investors bid the stock up to an unheard-of 95 times
earnings. Never before had a large-capitalization stock been
priced so high. But Polaroid’s earnings growth had exceeded
40% a year over the previous 14 years, and the future seemed
even brighter.

“IBM became the most valued stock in the world in 1967 and
held on to that position for more than six years. The dominant
computer manufacturer enjoyed enviable margins and virtually
no competition. Its stock value reached 50 times earnings, a
striking multiple for the world’s largest company. But why not?
IBM had regularly cranked out 20% annual increases in earnings
from the early 1950s, and the future obviously belonged to
technology.

“Yet investors who purchased these and many other stocks when
the future looked brightest had much to regret. Polaroid faltered
badly, and its stock gave investors ‘negative’ total return over the
next 30 years. And despite IBM’s comeback under CEO Lou
Gertsner, the company’s return has been less than half that of the
Standard & Poor’s 500 index over the past generation.

“These examples are typical. History has shown that whenever
companies, no matter how great, get priced above 50 to 60 times
earnings, buyer beware. A few stocks of the nifty-50 era
subsequently outperformed the market, but in that venerated
group no stock that sold above a 50 price-to-earnings ratio was
able to match the S&P 500 over the next quarter century. Such
great companies as Baxter Labs, Disney, McDonald’s, Johnson
& Johnson, AMP and Texas Instruments have trailed the
averages.

“But many of today’s investors are unfazed by history – and by
the failure of any large-cap stock ever to justify, by its
subsequent record, a P/E ratio anywhere near 100. As the chart
nearby shows, of the 33 stocks (18 tech and 15 nontech) that
have a capitalization over $85 billion today, an incredible nine
currently have P/E ratios in excess of 100, and six of those are in
the top 20.

“Supporters of these valuations point to their fantastic growth
and rosy prospects. And indeed, analysts’ estimates of future
earnings growth have predicted that these stocks’ earnings per
share will grow more than twice as quickly over the next five
years as the S&P 500.

“But once a firm reaches big-cap status – ranked in the top 50 by
market value – its ability to generate long-term double-digit
earnings growth slows dramatically.”

Professor Siegel later concludes:

“What does all this mean? Our bifurcated market has been
driven to an extreme not justified by any history. The excitement
generated by the technology and communications revolution is
fully justified, and there is no question that the firms leading the
way are superior enterprises. But this doesn’t automatically
translate into increased shareholder values.

“Value comes from the ability to sell above cost, not from sales.
If sales alone created value, General Motors would be the
world’s most valuable corporation. In a competitive economy,
no profitable firm will go unchallenged. Margins must erode as
others chase the profits that seem so easy to come by now. There
is a limit to the value of any asset, however promising. Despite
our buoyant view of the future, this is no time for investors to
discard the lessons of the past.”

Siegel had a chart with various statistics as of 3/7/00. For
example, Cisco Systems’ market cap then was $452 billion.
Today it is $162 billion.

And check out some of the P/Es, based on trailing 12 months
earnings, for these companies back in the spring of 2000.

Cisco 148
Oracle 152
Sun Microsystems 119
EMC 115
JDS Uniphase 668
Qualcom 166
Yahoo!...623

I went back, using Yahoo Finance, to check out the share prices
of various issues cited by Professor Siegel in his op-ed and it’s
yet another trip down memory lane.

3/10/00 the day of the top in Nasdaq

Cisco $136
Oracle $81
EMC $130
JDSU $260
Qualcom $136
Yahoo $178

Now before you say, ‘wait a minute didn’t some of them split?’
Yes, but what’s funny is that in the case of Cisco, Oracle, EMC
and JDSU, for example, the splits occurred within weeks of the
top (of course the companies announced them earlier than that).
JDSU actually split 2-for-1 the day after Nasdaq peaked. Cisco
split a few weeks after.

Underneath my desk blotter, filled with postcards of Pieter
Bruegel winter scenes and one of Shea Stadium, I have this piece
of scrap paper with some of the all-time highs (split-adjusted) for
various tech stocks as well as the day it was achieved. Not all
were on or about March 10, 2000, but all occurred in 2000.

Cisco $82 [3/27/00] today $27 (2/1/07 rounding off)
EMC $105 [9/25/00] $14
Intel $76 [8/28/00] $21
Oracle $46 [9/1/00] $17
Sun Micro $65 [9/1/00] $6.50
JDSU $153 [3/7/00] $17
Juniper $245 [10/16/00] $18

But back to price / earnings multiples, in Jeremy Siegel’s March
2000 op-ed he also looked at the potential P/E for selected tech
giants given estimated growth rates from 2000-2005. So keeping
in mind his research on stocks with above 50 P/Es, even looking
five years into the future you could project:

Cisco 73.9 P/E today Cisco’s P/E is 28
Oracle 91.3
Sun Micro 82.8
EMC 54.0
JDS Uniphase 195.5
Qualcomm 61.8
Yahoo!...122.6

Needless to say it didn’t quite work out for the sector like many
had planned in those days. But Professor Siegel nailed this
whole topic like no other and for this alone he’ll be forever
remembered by market historians, aside from his other fine work.

But I bet a few of you were reading this and thinking of Google.
After the release of its earning for the fourth quarter 2006, as I
write Google’s P/E based on 12 months trailing is about 50 and
the latest estimate for earnings for 2007 is over $14 and headed
higher, I imagine. Ergo, trading at $500 you can do the math. It
doesn’t necessarily fit Siegel’s model, though I hasten to add I
am not offering an opinion on Google’s shares myself. I’ll
continue to reserve any such comments for my “Week in
Review” column.

*Follow-up: For those of you who follow the “January Effect”
and read my annual piece on it a few weeks back, the S&P 500
did finish the month up 1.4%, with the Dow Jones up 1.3%. So
if you believe in the adage “As January goes, so goes the year,”
you can take heart in this.

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Back next week when I attempt to tackle the global fish issue.

Brian Trumbore

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