Wednesday, December 14, 2016

Is Today's Amazon, Facebook, Google The Cisco, Intel, Microsoft Of The Internet Bubble?



Have the recent run-up in the market and continued lofty future expectations for Google, Amazon and Facebook pushed these stocks into bubble territory?
Just as Google, Facebook and Amazon have created brand new, dominant businesses with seemingly boundless growth, the same was true for Cisco, Intel, and Microsoft in the late 1990s.
Cisco, Intel, and Microsoft have grown revenues and earnings since their peak valuation at the turn of the century, yet their market capitalizations are dramatically (80%-50%) lower today.
In today's market, Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB), and Google (NASDAQ:GOOG) are awarded high PE and PS multiples that are well deserved based on their innovative and scalable business models, wide moats and almost impregnable market leadership positions. However, the million-dollar (or trillion in this case) question is whether these valuations are justified or the expectations for these companies have gotten so lofty that they will have a decade or more of disappointing returns, just as Cisco (NASDAQ:CSCO), Intel (NASDAQ:INTC) and Microsoft (NASDAQ:MSFT) did since 2000. As this article will show, while there are certain striking similarities with the old favorites (as I will call Cisco, Intel and Microsoft the rest of this article), the new favorites (as I will call Amazon, Facebook and Google) are actually not as richly valued as the old favorites were at the turn of the century. Furthermore, the revolutionary businesses of these new favorites are more scalable and have a larger available market than the old favorites.
Just as Amazon, Facebook, and Google created entirely new technologies, businesses, and industries, so did Cisco, Intel, and Microsoft - and to a large extent, they still dominate their fields: Cisco in internet hardware, Intel in microprocessors and Microsoft in operating systems. However, as their industries matured and their growth rates have stalled, all three are looking to adjust their business models to reignite growth: Cisco is heavily investing in software, Intel is dominating in the data center (which Amazon and Google dominate) and Microsoft is making a big push into the cloud (one can argue that it is going to be as dominant as Amazon and Google) itself and going to a subscription-based model for some of its products such as Microsoft Office.
It was not always so, however, as the turn of the century awarded these companies half a trillion dollar valuations (more in inflation adjusted terms - see table 1), as well as lofty P/E and P/S ratios worthy of the masters of the universe that they were at the time.
Table 1: Key Financial Metrics for Cisco, Intel and Microsoft

Sources: Google Finance, Company Annual Reports and Websites,, BLS, Author's Work

The internet bubble has long since burst and these companies no longer command the valuation metrics that they once did. With slowing growth and mature businesses, investors are mostly disinterested. Except for Microsoft - the only one of the three to show an increase in its stock price (but not market capitalization) both Cisco and Intel are trading at a lower stock price then they did 16 long years ago!
So, the question is, are investors setting themselves up for a similar decade+ of disappointment with the new masters of the universe: Google, Amazon, and Facebook? Or is the valuation not as rich, leaving further room for the new favorites continue their run to higher records, even superseding the market capitalization of the old guard seen during the internet bubble?
This article will focus primarily on the financial metrics to compare the valuation of the new market darlings vs. the metrics of Cisco, Intel, and Microsoft during the times of the internet bubble. It will not delve into the business models, competition or potential disruptive technologies that may unseat them as this would be mostly subjective and one seldom sees the knock-out punch coming. In fact, one can argue that Cisco, Intel, and Microsoft continue to dominate their fields, even as the technology landscape evolves and changes around them. So, the reason they have lost 50-80% of their market capitalization in the last 16 years is not so much that they became irrelevant or obsolete (such as a Kodak), but despite their growing business and strong profitability, they are mostly getting a yawn from indifferent investors.

Revenues and Earnings:

Just to be clear, Cisco, Intel and Microsoft have not faded away to irrelevance. They continue to be the leaders in their fields, pumping out billions of dollars of sales and profits (over $40B worth this year alone - and that is profits!). That has not changed since the internet bubble. If anything, they are making more in revenues than they ever did during the internet bubble. As Chart 1 illustrates, the combined and individual revenues (adjusted for inflation), of the "old favorites" have all grown. Revenues have almost tripled for Microsoft and doubled for Cisco while Intel has managed to grow its revenues by over 20%. These are not the amazing growth rates of the go-go nineties, but they are more than respectable for mature or maturing businesses. Yet, as we will see, when expectations are as high as they were for these companies, even tripling revenues or net income (as in the case of Cisco - see Chart 2) is not enough.

Sources: Google Finance,, Company Investor Websites, Author's Work
What is curious is that the "new favorites," Amazon, Facebook, and Google, despite their relatively shorter lifespans, have already exceeded the aggregate sales of the old guard. This can be a bit misleading, however, as Amazon's sales skew the results significantly yet their business is not nearly as profitable as any of the old guard. Even so, Google has managed to exceed the sales of Intel and Cisco while Facebook has come out of nowhere to register $27B in sales. This is a huge testament to the scalability of the new favorites' business models and a strong argument for their continued fast growth even as we enter the realm of large numbers.
Taking a closer look at the net income side of things - of the old favorites, only Intel was not able to deliver net income growth (on an inflation-adjusted basis) over the past 16 years as its business has gotten more commoditized with competition coming from tablets and smartphones where the company does not enjoy the same dominance as it once did in personal computing. And yet, the three have grown their inflation-adjusted aggregate net income by ~30% over the past 16 years.
Table 2: Key Financial Metrics for Amazon, Facebook and Google

Source: Google Finance,,, Company IR Websites, Author's Work
On the other hand, Google is set to deliver more in net income than any of the old favorites, and Facebook has once again gone from zero to $10B in net profits in no time to challenge Intel and Cisco's net incomes. What is amazing is that while they are estimated to make ~$33B in net income this year, owing to their scalability and growing businesses, the three are expected to deliver over $42B in profits (according to analysts' estimates from - See Table 2 ) exceeding what the old favorites are estimated to make this year.

Importance of Sentiment and Expectations:

Nothing can illustrate the change in investor sentiment from the internet bubble to today as clearly as the PE and PS multiples awarded to the old favorites:
Source: Google Finance,,, Company IR Websites, Author's Work
Incredibly, Cisco's Price to Sales ratios has decreased from 31X to 3.2X, or a ~10X decline, over the past 16 years. Although not as dramatic, both Intel and Microsoft have seen ~5X decline in their PS ratios as shown in Chart 3a.
Interestingly, when compared to the PS ratios of the old favorites during the internet bubble, the PS ratios of current favorites look downright reasonable, despite their high absolute value (13X for Facebook, 8X for Google and 3X for Amazon).
Not surprisingly, as illustrated in Charts 4a and 4b, a similar story plays out. We see a dramatic compression in PE multiples for the old favorites while the new favorites' PE ratios (except for Amazon, due to its low margins and heavy reinvestments in its business) lower than what the old favorites commanded during the internet bubble.

Source: Google Finance,,, Company IR Websites, Author's Work

Market Capitalization:

To me, this is the most striking part. Even though these companies have bought back monstrous amounts of stock over the past 16 years (offset by generous amounts of stock options, mostly for senior management, of course) (see table 1) their stock prices have actually declined (Cisco, Intel) or barely moved (Microsoft) - with their market capitalization registering even more significant declines. To make matters worse, these companies have borrowed heavily to finance these stock buybacks (they still carry a lot of cash or cash equivalents on their balance sheet but a significant amount is kept overseas to avoid paying repatriation taxes).

Source: Google Finance,, Author's Work
As Chart 5 Shows, the old favorites, at their peak market cap, had a combined valuation of close to $2.5T (that is T as in Trillion) when adjusted for inflation. In comparison, today their market capitalization is a third of what it used to be (~ $800B) despite their higher sales and earnings. As for the market capitalization of the new favorites, it stands at around half ($1.3T) of what the old favorites were worth at the turn of the century.
Source: Google Finance,, Author's Work
Chart 6a and 6b illustrate just how much damage high expectations caused in the underperformance of the stock prices. Chart 6a shows what fraction of the inflation adjusted market capitalization each of the old favorites commands today. Cisco, is trading at less than 20% of where its inflation-adjusted market cap was in 2000. Intel is at 24% and Microsoft at 54%. Mind you, this is 16 years later.
Of course, this is not what an investor would have lost if they had purchased the stock at its peak market value and held it through Tuesday's (December 13th) close. As mentioned earlier, these companies have spent lavishly buying back their shares (new favorites are still issuing more shares than buying back, thus growing the diluted share count). As such, the stock prices for Cisco and Intel have "only" declined 61% and 50%, respectively (in absolute terms, that is; would be worse if adjusted for inflation), while Microsoft registered a slight gain (again, would have been negative if adjusted for inflation). However, the dividends paid over the past 16 years by the old favorites (none of the new favorites pay a dividend) have somewhat offset these declines.


For those investors (including myself) who have lived thru the internet bubble, the memory of Nasdaq losing close to 80% of its value is still etched into their consciousness. It has been more recently refreshed with the memory of the Great Recession with S&P 500 losing close to two-third of its value. As such, we are naturally cautious of outlandish valuations. Even so, compared to the valuations assigned to Cisco, Intel, and Microsoft at their peak valuations (let alone some of the companies that used to be valued on "eyeballs" (a slick metric that was used to value internet companies with little or no sales, instead tracking how many times a site was visited etc.), Amazon, Facebook and Google look not nearly as outlandish as one may initially think.
Furthermore, these companies are highly profitable and scalable, and one could easily justify them one day being worth more than what the old favorites were at their peak due to the larger economy and increased consumers of technology. While in my estimation these companies have more runway to grow earnings, sales and market values and quite possibly become the first Trillion-dollar market-cap companies, the large unknown is what the inevitable maturing of their businesses will do their PE ratios.
Personally, I am long all six names to varying degrees. While my largest holding of the six is Amazon - it is mostly due to the huge run-up the company had over the past five years, and I was fortunate enough to build a reasonably good position in the stock in the 2010-2014 time frame (I did sell some in the last six months but I am holding on to the majority of my positions). I have smaller positions in Cisco - which I have added to recently after its decline due to last quarter's disappointing earnings release, and Facebook - after the stock declined when the company told investors to expect slowing growth in 2017. I also have a position in Microsoft which I think has successfully reignited growth in its businesses (the company is once again commanding higher valuation metrics from investors) and a very small position in Intel due mostly to sentimental reasons (where I spent most of my career).
Last but not least, my second largest holding, Google, is my favorite of the six for the next decade. I would like to build a more meaningful position in Google (if there is interest from this article - I am thinking about doing an article primarily focused on Google) - I have purchased Google shares on and off in very small amounts during pullbacks, hoping for more meaningful declines that never came. However, even at present valuations, I think a patient investor can have more than acceptable returns. As any internet-based business reliant on Google searches can attest, they are almost completely dependent on Google searches for customer acquisitions (unless your name is Amazon or Facebook, of course). A reliance that will only grow as more and more businesses are started on the internet or shift to the internet. Unless Bing or another search engine is able to make a meaningful dent in Google's search and advertising businesses (which I just don't see at least in the next 3-5 years), Google will not only maintain or improve pricing power but also grow its customer base, resulting in further earnings growth, and growing into its what seems like lofty PE and PS multiples.
I look forward to your comments and thoughts.


I am/we are long GOOG, AMZN, FB, INTC, MSFT, CSCO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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