A Tale Of Two Leaders

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

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.

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