Call me old-fashioned, but I believe valuations still matter.
It's easy to see the market hit all-time highs and want to get a little more skin in the game. It's normal to try and ride the hottest stocks higher, betting on more fast gains.
This strategy might work as a trade. But the fundamental investor in me has to remind everyone that prices matter. Paying a sky-high valuation for a flashy stock will burn you in the end more often than not.
As an example, think of Cisco Systems (CSCO) back in the early 2000s.
Cisco reaped the benefits of the dot-com boom, though it wasn't a literal "dot-com company." It made the routers and switches behind the Internet network that the dot-com companies operated on.
Cisco's position was dominant. As of 1996, it controlled 78% of the router market. And it enjoyed strong margins and returns on capital.
By early 2000, the dot-com bubble expanded, and telecom companies invested in a massive build-out of Internet and broadband networks. As investors got giddy about astronomical growth, Cisco's price-to-sales ratio soared to 63 times.
Of course, the Internet bubble burst. And wild spending on expanding the Internet ended. Cisco started losing money, and its valuation collapsed. Shares fell 86% by late 2001...
That said, all the rosy predictions about Cisco's business came true...
The company still dominates networking equipment – though not quite as thoroughly as it did at the time. Its operating income rebounded rapidly and has climbed for two and a half decades.
And in just the past 10 years, shares have returned 12.8% per year when you account for dividends.
This is a perfect example of what we call the "valuation life cycle"... A young, fast-growing company sports a high multiple. That multiple decreases as the company matures and the hype fades. But the rising earnings and the lower multiple can still combine to deliver positive returns for investors.
Cisco's operating income has grown to an average of more than $3 billion per quarter. And its valuation has compressed to less than 5 times sales.
If you had bought Cisco at its absurd valuations in early 2000, you'd have lost money over the past quarter century. But if you had bought into this business at almost any other time following the dot-com crash, you'd have done very well.
You just can't win buying at 63 times sales. Over the past 12 months, though, Cisco has traded for a reasonable price. And it's a company returning a lot of cash to shareholders.
That's why we recommended buying shares in my income-focused newsletter Income Intelligence one year ago.
We're already up around 45%.
But the message here today is to pay attention to prices. We're seeing a lot of stocks trading for nosebleed valuations... And it's going to be tough for many companies to grow enough in future years to deserve these valuations.
The much-hyped Palantir Technologies (PLTR), for example, is trading for 100 times sales.
Be careful with stories like these. You can end up losing a lot of money when the hype inevitably dies down. Instead, take a long-term approach and fill your portfolio with high-quality companies you bought at decent valuations.
Of course, finding solid companies to invest in has become much more difficult. According to my friend and 50-year Wall Street veteran Marc Chaikin, traditional metrics no longer work in today's innovation-driven, hype-fueled environment.
It all comes down to the fact that lackluster companies can deceive you with accounting tricks and make their numbers appear better than they really are.
Marc has a solution to this problem, however. He devised something called the "earnings quality" tool. Now, his subscribers can separate the trickster companies from those with genuine growth potential.
To learn more about this tool and how it can help you, click here.
What We're Reading...
- For Income Intelligence subscribers, check out our original Cisco recommendation... I Can't Bite My Tongue Any Longer.
- Something different: As Squid Game ends, South Koreans return to the reality that inspired it.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig and the Health & Wealth Bulletin Research Team
July 2, 2025