Cisco Systems, Inc. (CSCO), manufactures and sells networking and communications equipment for transporting data, voice, and video and provides services related to that equipment. Its products include routing and switching devices; home and office networking equipment; and Internet protocol, telephony, security, network management, and software services. The firm has grown organically but also through acquisition of other networking and software firms. Cisco's Web site is Cisco was a darling of the Internet boom, one of the few firms with concrete products. Indeed its products were important to the development of the infrastructure for the Internet age and the expansion in telecommunications. At one point, in early 2000, the firm traded with a total market capitalization of over half a trillion dollars, exceeding that of Microsoft, and its shares traded at a P/E of over 130. With the bursting of the Internet bubble and the overcapacity in telecommunications resulting from overinvestment by telecommunications firms, Cisco's growth slowed, but it certainly was a strong survivor. By 2004 its revenue had recovered to the $22.0 billion level reported for 2001. In September 2004, just after its reports for fiscal year ended July 2004 had been published, Cisco's 6,735 million shares traded at $21 each on book value of $25,826 billion and a basic earnings per share for 2004 of $0.64. The firm pays no dividend. Analysts were forecasting consensus basic earnings per share of $0.89 for 2005 and $1.02 for 2006. Most analysts had buy recommendations of the stock, some had holds, but none was issuing a sell recommendation. With a beta close to 2.0, investment analysts were using a 12 percent required return for Cisco's equity at the time.
A. Bring all the tools in this chapter to an evaluation of whether Cisco's forward price earnings ratio in September 2004 is appropriate. You will not be able to resolve the issue without some detailed forecasting of Cisco's future profitability (which you should not attempt at this stage). Rather, quantify the forecasts implicit in Cisco's $21 price that could be challenged with further analysis. Identify the speculative components of Cisco's price using the building block approach. To start, you should calculate abnormal earnings growth for 2006 that is implied by the analysts' forecasts and take the analysis from there. Figures and should be helpful to you.
B. Analysts were forecasting an average target price of $24 for the end of fiscal year 2005. Is the target price consistent with a buy recommendation on the stock? Analysts were also forecasting a 145 percent five-year earnings growth rate. Is the buy recommendation consistent with the forecasts that analysts were making?

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