From hunch to reality: The harsh lessons of overpaying for tech momentum

*This content is supplied by Sean Peche, Portfolio Manager at Ranmore Fund Management Ltd

First appeared on LinkedIn

Sean Peche takes us on a journey spanning 24 years, where a visionary investor set their sights on Cisco, the internet’s backbone. Inspired by Mark Twain’s wisdom, they dive into Cisco’s 1999 financial report, captivated by its exponential growth. Fast forward to today, expectations are shattered as reality hits hard. Lessons learned: overpaying for momentum can lead to losses. While the promise of AI echoes the internet’s impact some quarter of a century ago, history warns against exorbitant valuations. Mark Twain’s wisdom rings true: “Any price” for innovation may not yield the golden returns envisioned.

It’s 24 years ago, and your hunch is the “internet” will be big.

A friend quotes Mark Twain.

“During the gold rush, it’s a good time to be in the pick and shovel business’.

Wait, Cisco makes all the gear directing Internet traffic – internet “picks and shovels”!

You download Cisco’s 1999 10k titled “Capture the Momentum”.

Perfect!

You read, “Cisco is the worldwide leader in networking for the internet”.

See a bar chart showing:

– Sales growing from $2bn in 1995 to $12bn in 1999 and;

– Net income growing from $450m to $2bn.

There’s a picture of their CEO, John Chambers, saying: “We have been recognised as the fastest growing, most profitable company in the history of the computer industry”.

“The internet is driving a global economy that is creating unprecedented opportunities for countries, companies and individuals worldwide, and Cisco is proud to play a key role in leading this economy”.

And

“One day, a business that is not on the internet will not be in business”.

That’s it, I’m buying and holding!

Roll forward 24 years, and Cisco is now generating:

– Sales of $58bn, 5x more than in 1999

And:

– Net income of $14bn, 7x more.

And Chambers was right, “if you aren’t on the internet, you aren’t in business”.

So you high-five yourself and go to count your winnings.

But you’re down -23%.

This can’t be right.

-23% after 24 years?

When I nailed the thesis?

In fact, internet traffic volume is way higher than I forecast thanks to:

-streaming;

– gaming;

– phones with 4 cameras;

– TikTok and Facebook etc.

And yet I lost money over 24 years?

Even worse, in October 2004, you were down 84%!

But how?

It is very simple – you overpaid trying to “capture the momentum”.

Because when you paid $400bn for $12bn of sales in 2000, you paid 33x sales.

And that’s pricing in a lot of great news.

Even if your profit margin were 100%, you’d need 33 years to recoup your investment if you received all profits in dividends.

Spoiler alert – tech companies aren’t big dividend payers; they need the cash to buy back shares from the staff.

What’s your point?

People who own Nvidia because they make the AI “picks and shovels” are paying 40x sales.

And yes, “AI will change the world” (like the internet).

And yes, “Nvidia is the leader” (like Cisco).

And yes, “Jensen Huang is a visionary” (like Chambers).

But unlike Nvidia, Cisco’s largest clients weren’t all working on their solutions.

And back then, Cisco was working WITH China and China Telecom.

Chips and China don’t mix well these days.

Now, Nvidia has costs and generates free cash flow.

But it also spends that on buying shares from staff and R&D trying to fend off customers who could soon become competitors…

Mark Twain never said you could pay ANY PRICE for those “picks and shovels”.

Disclaimer:

Ranmore Fund Management Ltd is authorised and regulated by the UK’s Financial Conduct Authority
The content of this marketing material is provided for information purposes only. It does not constitute or form part of any offer to issue or sell, or any solicitation of any offer to subscribe or purchase shares, units of other interests in investments.
Past performance does not predict future returns.
Funds managed by Ranmore Fund Management Ltd have no positions in the aforementioned shares.