Money Magazine Article

Below is an article from Michael Sivy from Money Magazine. It has many of the terms and concepts that we are studying in this section of the course. Top-down, bottom-up analysis and company earnings forecasts are all included.

SIVY ON STOCKS from CNNmoney.com November 5, 2001

Turnaround in tech?

The sector is rallying on Cisco's earnings and the likelihood of a Fed rate cut. But will it last?

By Michael Sivy

NEW YORK (CNNmoney) - Tech stocks have been showing some resilience in the past few days, thanks to expectations that the Federal Reserve will cut interest rates for the tenth time this year on Tuesday. The sector also got a lift from Cisco's quarterly results, announced after the market closed on Monday. As investors hoped, Cisco reported positive earnings, two cents above analysts' consensus estimates.

Neither lower interest rates nor Cisco's slight profits will guarantee a
rebound in the technology sector. But in context, investors are clearly
interpreting them as very bullish signs. Advanced Micro Devices, Juniper Networks, Nortel Networks and Sun Microsystems all posted significant gains on Monday. And as of Monday, the Nasdaq Composite had more than made up its losses after the Sept. 11 attack -- and it was up 26 percent from its Sept. 21 low.

To decide whether these gains are just a bounce or the beginning of a sustainable advance, it helps to look at where both interest rates and Cisco's earnings go from here.

The Fed has cut rates nine times since January -- so far, with little
positive effect on the economy. Because unemployment jumped a hefty half percentage point in October, the Fed will probably cut rates again this week. Analysts are divided whether the next cut will be one quarter or one half point.

Either way, they agree that the Fed has reduced rates just about as much as it can -- and those cuts should pull the economy out of recession early next year. The current consensus forecast is for a small decline in real GDP in the fourth quarter, followed by a small gain in the first quarter that should accelerate to growth of more than 3 percent at an annual rate before the end of 2002.

Obviously, military events or another serious terrorist incident could
radically alter that outlook. But in the absence of such external shocks,
it seems likely that Sept. 21 will turn out to have been the bottom for the Nasdaq.

That cautiously optimistic top-down picture is certainly supported by the bottom-up outlook. Though still down sharply from year-ago levels, Cisco's most recent revenues and pro-forma earnings both showed gains for the first time in three quarters. Speaking with analysts after the results were reported, CEO John Chambers told analysts that Cisco expected single-digit gains going forward. But he also stressed that earnings couldn't be projected more than a couple of months out and that the overall environment for tech remained difficult.

There are also grounds for caution if you consider Cisco's projected
results. Even in a best-case scenario, Cisco's earnings would not surpass last year's peak levels until the second half of 2003 at the earliest. And the stock's price/earnings ratio won't come close the 100-plus P/E it carried before the tech wreck.

When you work out the actual numbers, you get a good gauge of the
opportunities -- and risks -- in tech. Within the next two or three years,
Cisco (CSCO: up $0.64 to $17.90, Research, Estimates) should top the 53 cents it earned in fiscal 2000. Say that the stock carries a premium P/E of 40 or even 50 at that point. Those figures would translate into a share price of $28 at the most. From current levels, that's a compound annual return between 15 and 23 percent.

The risk is that bad war news or an unexpectedly bad recession sends the Nasdaq back down to retest its lows, a decline of more than 20 percent. On balance, the odds favor the positive scenario. But the likely gains are not as big as one might think -- and the risks are not trivial. My conclusion is that investors should now be buying tech on the assumption that the worst is past. But I don't see any reason to hurry or to overpay. There's still plenty of quagmire to slog through.