The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [191]
Finally, as Wharton finance professor Jeremy Siegel pointed out, no company as big as Cisco had ever been able to grow fast enough to justify a price/earnings ratio above 60—let alone a P/E ratio over 200.3 Once a company becomes a giant, its growth must slow down—or it will end up eating the entire world. The great American satirist Ambrose Bierce coined the word “incompossible” to describe two things that are conceivable separately but cannot exist together. A company can be a giant, or it can deserve a giant P/E ratio, but both together are incompossible.
The wheels soon came off the Cisco juggernaut. First, in 2001, came a $1.2 billion charge to “restructure” some of those acquisitions. Over the next two years, $1.3 billion in losses on those “investments” leaked out. From 2000 through 2002, Cisco’s stock lost three-quarters of its value. Sysco, meanwhile, kept dishing out profits, and the stock gained 56% over the same period (see Figure 18-1).
Pair 2: Yahoo! and Yum!
On November 30, 1999, Yahoo! Inc.’s stock closed at $212.75, up 79.6% since the year began. By December 7, the stock was at $348—a 63.6% gain in five trading days. Yahoo! kept whooping along through year-end, closing at $432.687 on December 31. In a single month, the stock had more than doubled, gaining roughly $58 billion to reach a total market value of $114 billion.4
FIGURE 18-1 Cisco vs. Sysco
Note: Total returns for calendar year; net earnings for fiscal year.
Source: www.morningstar.com
In the previous four quarters, Yahoo! had racked up $433 million in revenues and $34.9 million in net income. So Yahoo!’s stock was now priced at 263 times revenues and 3,264 times earnings. (Remember that a P/E ratio much above 25 made Graham grimace!)5
Why was Yahoo! screaming upward? After the market closed on November 30, Standard & Poor’s announced that it would add Yahoo! to its S & P 500 index as of December 7. That would make Yahoo! a compulsory holding for index funds and other big investors—and that sudden rise in demand was sure to drive the stock even higher, at least temporarily. With some 90% of Yahoo!’s stock locked up in the hands of employees, venture-capital firms, and other restricted holders, just a fraction of its shares could trade. So thousands of people bought the stock only because they knew other people would have to buy it—and price was no object.
Meanwhile, Yum! went begging. A former division of PepsiCo that runs thousands of Kentucky Fried Chicken, Pizza Hut, and Taco Bell eateries, Yum! had produced $8 billion in revenues over the previous four quarters, on which it earned $633 million—making it more than 17 times Yahoo!’s size. Yet Yum!’s stock-market value at year-end 1999 was only $5.9 billion, or 1/19 of Yahoo!’s capitalization. At that price, Yum!’s stock was selling at just over nine times its earnings and only 73% of its revenues.6
As Graham liked to say, in the short run the market is a voting machine, but in the long run it is a weighing machine. Yahoo! won the short-term popularity contest. But in the end, it’s earnings that matter—and Yahoo! barely had any. Once the market stopped voting and started weighing, the scales tipped toward Yum! Its stock rose 25.4% from 2000 through 2002, while Yahoo!’s lost 92.4% cumulatively:
FIGURE 18-2 Yahoo! vs. Yum!
Notes: Total returns for calendar year; net earnings for fiscal year. Yahoo!’s net earnings for 2002 include effect of change in accounting principle.
Sources: www.morningstar.com
Pair 3: Commerce One and Capital One
In May 2000, Commerce One, Inc., had been publicly traded only since the previous July. In its first annual report, the company (which designs Internet “exchanges” for corporate purchasing departments) showed assets of just $385 million and reported