Cognizant Technology Solutions (CTSH) has been a star technology company, giving superb growth and returns over the last decade. Let me start by asking you which has been the best performing technology company in the past 10 years - Apple (AAPL), Amazon (AMZN), IBM (IBM), Cognizant or Priceline (PCLN)? I would expect that most of you would not come up with the right answer. The right answer is Cognizant, which has given an eye-popping 18596% return over the last decade, beating all of the above mentioned companies by a very wide margin. The reason you might have got the answer wrong is that the media and the investor community have been largely ignoring this stock, despite spectacular revenue and earnings growth. Cognizant has continued to outperform its larger Indian and U.S. competitors and has become the new "Infosys" of the computer services space. While Infosys is facing a revenue growth slowdown, Cognizant has continued to beat market expectations. We think that investors should look to buy dips, as the company has proven itself both during up and down cycles.
Cognizant - Lot of Things to Like
- Exponential Revenue and Earnings Growth - Cognizant has kept on growing revenue relentlessly in the last decade. The company has grown its revenue to ~$7.5 billion in 2012, from $229 million in 2003. The growth has been consistently strong and the 2009 crisis did nothing to slow down the high double-digit growth.
- Margins Stable despite High growth - CTSH has managed to keep its margin relatively stable, despite going against bigger and more reputed companies in the computer services space. The Operating Margin has been in the 18%-20% range, while the Net Margin has ranged between 14%-17%.
- Zero Debt - The company has accumulated $2.6 billion in cash and has no debt. In fact the company has no debt on its balance sheet for the last four years. The company is adding almost $600-$700 million in cash every year, making the balance sheet grow stronger and stronger. Almost 12% of the company's market capitalization is now accounted by cash.
- Stock Buyback expansion, Dividends could be a catalyst - The company has increased its earlier $600 million buyback program to $1 billion, as it looks to return the cash to shareholders. We think a dividend would help push the stock higher.
- Great Management - It would not be wrong to say that Cognizant has one of the best management teams amongst the top Indian software service companies. While Wipro (WIT) and Infosys (INFY) have seen substantial churn in their top management due to growth concerns, Cognizant has an excellent top management, which has been leading the company for a long time.
- Client Focus has helped Cognizant outperform - CTSH has differentiated itself from other Indian technology companies through deeper engagement with its clients. Its sales and marketing spend has been higher than its peers, as it has spent more money in forming deeper relationships with its clients. The company hires more MBAs in India than any other technology company. This has given the company an edge in business relationships compared with the technology focus of its peers.
- Bigger Scale will let it dig for even Bigger Deals - As Cognizant has grown to become one of the biggest pure play services players, the company can compete with IBM , Accenture (CAN) and other big players for multi-million IT outsourcing contracts. Around $50 billion in service deals are expected to come up for renewal in 2013. I expect CTSH will win a bigger market share post 2013.
- Slowing IT Spend - The slowing global economy is having a detrimental effect on IT spending, as companies become cautious on discretionary spending. If the global economy slows down more than expected, then CTSH will face an even bigger macro headwind. Though the company has managed to navigate the 2008 slowdown quite well, the growth rate will still be impacted.
- Need to move to Higher Value Added Services - CTSH like other Indian IT companies have failed to offer high-end consulting and business services. The company needs to move up the services space, to offer high end management and business consulting like IBM and Accenture. There is a limit to how much you can grow the lower end IT off shoring service model.
- Wage Inflation and Rupee Appreciation - India has been witnessing significant wage inflation and while the Rupee has fallen quite a bit against the dollar, there is a risk that it can start to appreciate again. With most of CTSH costs denominated in rupees, this remains a risk to CTSH future earnings.
- Stock is near all-time Peak - I don't think this is a negative in case of CTSH, which has been forming new highs almost continuously over the last 10 years or so. The company is currently trading at its all-time peak of ~$78, which is almost 40% higher than its 52-week low of ~$54/share. The company's stock fell sharply in May 2012, after it lowered its 2012 guidance. However the stock has recovered all its losses since then, as investor concerns about growth slowdown have subsided.
Stock Valuation is Comparable to Peers
CTSH is neither cheap nor expensive, with a P/S of 3.4x and P/B of 5.2x. The forward P/E of ~17x is also not expensive given the forward growth projections. In comparison Infosys trades at a P/S and P/B of 4.1x and 4.4x respectively. The forward P/E at 16.3x is also very similar to that of CTSH.
We have been surprised at how little attention CTSH has got amongst the technology and financial media, despite the spectacular returns it has given. The main reason is that the company does not operate in the latest technology fashion areas of "daily deals" or "social media." This is probably the reason that the company has never seen irrational investor exuberance like other tech stocks such as Groupon (GRPN) or Facebook (FB). However, we think that CTSH remains one of the best technology stocks given its history of exponential growth despite strong competition, great management and an excellent balance sheet. We look to buy dips in CTSH as the company still has a lot of space to grow.