Seeking Alpha
Profile| Send Message|
( followers)  

Cognizant Technology Solutions Corporation (CTSH) is a leading provider of information technology, consulting, and business process outsourcing services in Asia, Europe, and North America. A Teaneck, New Jersey-based company serves a diversified portfolio of clients in the financial, healthcare, retail, manufacturing, and logistics industries. As a result of its high-quality consultative approach and extensive customer partnerships, the company showed an outstanding performance in terms of revenues as well as profits.

As of August 30, Cognizant stock was trading at $62 with a 52-week range of $53.54-83.48. It has a market cap of $19.1 billion. Trailing 12 month P/E ratio is 23.8 and forward P/E ratio is 18.4. P/B, P/S, and P/CF ratios stand at 4.8, 3.6, and 22, respectively. The three-year annualized revenue and EPS growth stand at 29.10% and 27.30%, respectively. Operating margin is 18.70% and net profit margin is 15.4%. Cognizant does not have a dividend policy.

Cognizant has a three-star rating from Morningstar. While its trailing P/E ratio is 23.8, it has a five-year average P/E ratio of 29.6. Out of 28 analysts covering the company, 19 have buy, three have outperform, and six have hold ratings. Wall Street has close-range opinions on Cognizant’s future. The bottom line is 13.9% growth and the top-line growth estimate is 33.1%. Average five-year annualized growth forecast estimate is 20.9%.

What is the fair value of Cognizant given the forecast estimates? In this article, the 15th in a long series, I will show a step-by-step calculation of Cognizant’s fair value using discounted earnings plus equity model.

Discounted Earnings Plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:

V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value

V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]

The earnings after the last period act as a perpetuity that creates regular earnings:

Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r

While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.

Cognizant’s Valuation

Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.

Since we are in the middle of the year, it will be more feasible to take the average of ttm EPS of $2.66 along with the mean estimate of $3.39 for the next year.

E0 = EPS = ($2.66 + $3.39) / 2 = $3.025

Wall Street holds diversified opinions on Cognizant’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 20.9%. Book value per share is $13.01.

The rest is as follows:

Fair Value Estimator

V0

E0

$3.03

V1

E0 (1+g)/(1+r)

$3.29

V2

E0((1+g)/(1+r))2

$3.59

V3

E0((1+g)/(1+r))3

$3.91

V4

E0((1+g)/(1+r))4

$4.26

V5

E0((1+g)/(1+r))5

$4.64

D

E0(1+g)5/[r(1+r)5]

$42.16

BV

Equals

$13.01

Fair Value Range

Lower Boundary

$64.87

Upper Boundary

$77.88

Potential

25.61%

I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5 year discounted-earnings-plus-book-value model, the fair-value range for Cognizant is between $64.87 and $77.88 per share.

As of Aug 30th, Cognizant was trading at a price of $62. I like Cognizant as a company. Cognizant is a member of the S&P, the Forbes Global 2000, the Fortune 500, and the NASDAQ-100. The company is ranked among the top performing and fastest growing companies in the world. I see great growth potential, as well. The market has under-priced Cognizant’s growth potential. The current price of $62 indicates the stock is undervalued. Based on my FED+ fair value estimate, Cognizant is 25% cheaper than my fair-value range. The stock has to rise by 25% to be fairly-priced.

O – Metrix Confirmation

If the math above looks too complicated for you, try estimating the fair value using the O-Metrix as such:

O-Metrix = [(Dividend Yield + Growth Estimate) / (P/E Ratio)] * 5

  • Dividend Yield: Higher is better.
  • EPS Growth: Higher is better.
  • P/E Ratio: Lower is better.

The back-testing of this valuation technique on 40 large-caps shows that O-Metrix works very well over the long-term, such as five years. I am also continuously checking on specific sectors, and the formula works very well so far.

What is the O-Metrix Score?

  • Cognizant does not have a dividend policy. Therefore, the yield is 0.
  • Growth estimate is the same as the discounted earnings model and is equal to 20.9%.
  • Since we are at the middle of the year, taking the average of ttm (23.8) and forward (18.4) P/E ratios will smooth the results. Thus, the average P/E ratio to be used in the model is 21.1.

O-Metrix = [(20.9 + 0) / (21.1] * 5 = 4.95

Depending on the benchmark chosen, the market has an O-Metrix score range between 4 and 5. Cognizant's O-Metrix score of 4.95 is on upper-end of the fair-value range. Back-testing of this ranking system shows that companies with higher-than-average O-Metrix scores beat the market with lower volatility. At a price of $62, the company is trading within the C-Grade, on-average-return zone.

[Click to enlarge]

Summary

Cognizant’s stock has always been priced at a premium due to its high growth potential. The average P/E ratio in the last five years was 29.6. The stock has debt to equity ratio of 0 and beta of 1.11. The stock has a relatively high PEG ratio of 1.17. It is trading with a slightly high P/E ratio of 23.8, and a forward P/E ratio of 18.4. In the last five years annualized EPS growth was 33.2%.

As of Aug 30, Cognizant was trading at $62, lower than my fair-value range of $64.87 - $77.88. Analysts mean target price of $82.64 is a little more than the upper end of my fair-value estimate. Trailing twelve month ROA ratio of 19.04 and ROE ratio of 23.63 are well-above the market. The stock lost 16% in the last quarter. It is trading 25% lower than 52-week high. I think the current price offers an entry point below its fair value range.

Source: Cognizant Technology A High-Growth Stock Priced Below Its Fair Value