A Tale Of Two Leaders

By Paul Shread | April 30, 2001
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Cisco and Microsoft, the twin pillars of the 1990s technology bull market, have been parting ways as of late.

Microsoft is up more than 60% off its lows and is once again a darling of investors. Cisco , on the other hand, is sitting just above its 52-week low and has been a laggard in the Nasdaq's recent 25% run.

Microsoft , like most tech leaders, is busy positioning itself for the Internet age. It's turning toward enterprise software to fuel its growth, in the process targeting companies like Oracle and Sun Microsystems that have long feared what the software king could do to them. The company is also maintaining its earnings at a time when other tech bellwethers like Sun and Cisco are seeing earnings fall by 25% to 87%.

As a result, investors are rewarding the stock. Mr. Softie has broken its year-long downtrend and is testing the neckline of an inverted head and shoulders bottom at 71 (see chart below). A close above 72.50 could lead to a test of its main downtrend line above 90. It's not clear if the stock will be able to do that, but it's one of the nicest-looking bases among tech leaders.

Contrast that pattern with Cisco's (see chart below). Cisco has barely broken its steepest downtrend line - and has reversed downward to retest it. The stock has no visible base to build off of and can't seem to get going.

Cisco sharply built up its inventory to meet demand, and then was stuck with $2.5 billion in essentially worthless inventory when the economy headed south. It is competing with its own second-hand products offered at a fraction of the price by distressed companies, and is losing high-end market share to competitors like Juniper Networks and Ciena .

Neither Microsoft nor Cisco is cheap at these levels. Both have price-to-earnings ratios of 37-38. But Cisco's earnings are expected to fall by 9-12% over the next 5 quarters, while Microsoft is expected to grow earnings by 10% over that time period. An economic recovery would no doubt improve those valuations, but for the time being, investors appear willing to pay up for Microsoft's dependability.

If investors have rewarded anything over the last few months, it has been market share gains. Dell , Nokia and Juniper have all gained market share, making them a good bet for an eventual economic recovery. Microsoft has the dominance and pricing power to dwarf all of them. Microsoft's business model is similar to that of a drug company: the company spends a lot in research and development to make the first product, but each subsequent one out the door costs just pennies each. As long as Microsoft has good products in the pipeline, its earnings should be dependable, and Microsoft is entering a sweet spot in its cycle over the next several months.

Cisco may have invented the router, but the company faces a crisis that was almost unimaginable just a few months ago. There are signs that the company is retooling its focus from market share to inventory control and profitability. Those steps should help the company's bottom line, but it remains to be seen if CEO and consummate salesman John Chambers can lead Cisco through tough times as well as he did through the company's boom years.

The saying used to be that as Cisco goes, so goes the Nasdaq. Let's hope for the Nasdaq's sake that that's no longer the case. If anything, the charts might be saying that Cisco may no longer be the leader it once was, and that the next Microsoft might just be ... Microsoft.