Comparing America's 3 Largest Business Software And Services Companies

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Includes: ADP, CTSH, MSFT
by: Joseph Cafariello

Summary

The Business Software and Services industry is expected to outperform the S&P broader market substantially this quarter, underperform significantly next quarter, then outperform significantly in 2015 and beyond.

Mean/high targets for three largest U.S. Business Software and Services companies - Microsoft, Automatic Data Processing, Cognizant Technology - range from 6% below to 17% above current prices.

Find out which among Microsoft, ADP and Cognizant offers the best stock performance and investment value.

*All data are as of the close of Friday, November 21, 2014. Emphasis is on company fundamentals and financial data rather than commentary.

The Business Software and Services industry's main business activities are simple enough to describe:

"Business Software and Services companies deliver IT solutions for business use, including software development, maintenance and production support, and data processing."

Yet, the companies within the space are finding it necessary to locate their own little niche market where they can make a name for themselves as the number one dominant player.

For instance, the largest U.S. company in the group - Microsoft Corporation (NYSE: MSFT) - has grown well beyond its long-time bread and butter Windows and Office software to include the video gaming console Xbox and game software. It is also branching into cloud computing solutions for both consumers and businesses.

For its part, the second largest U.S. company in the industry - Automatic Data Processing, Inc. (NASDAQ: ADP) - has found its niche in employer solutions, covering assignment outsourcing, human capital management, payroll services, employee benefits administration, time and attendance management solutions, insurance services, retirement services, and tax compliance solutions.

Meanwhile, the third largest U.S. company in the space - Cognizant Technology Solutions Corporation (NASDAQ: CTSH) - has made a name for itself in information technology consulting, operations improvement consulting, strategy consulting, systems integration, customer relationship management, as well as big data services in managing and interpreting data of ever increasing volume, variety, and complexity.

Comparing the three top U.S. companies in the industry over the course of the recent economic recovery shows just who has the right recipe for success in today's technology environment, as graphed below.

Since the start of the recovery in March of 2009, where the broader market S&P 500 Index [black] has gained some 205% and the SPDR Technology Sector ETF (NYSE: XLK) [blue] has gained 215%, ADP [purple] has risen 190%, Microsoft [beige] has climbed 223%, while Cognizant has soared 485%.

On an annualized basis, where the S&P has averaged 36.18% and XLK has averaged 37.94%, ADP has averaged 33.53%, Microsoft has averaged 39.35%, while Cognizant has averaged an astounding 85.59% per year.

Source: BigCharts.com

Looking forward, the Business Software and Services industry as a whole is expected to grow its earnings much more quickly than the broader market at some 3.13 times the rate over the immediate term, 2.25 times in 2015, and 2.08 times averaged over the next five years. Though, there is a little sluggish underperformance expected next quarter.

Zooming in a little closer, the three largest U.S. companies in the industry are expected to continue their split performance relative to the broader S&P, with Microsoft underperforming most the way except for 2015, ADP underperforming near term before outperforming longer term, and Cognizant outperforming most of the way except for next quarter.

Yet, there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?

Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.

A) Financial Comparisons

• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.

• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.

In the most recently reported quarter, Microsoft posted the greatest revenue growth year over year, while Cognizant posted the greatest earnings growth. At the slow growth end of the scale, ADP and Microsoft split last place finishes, with both reporting shrinking earnings.

• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes, and depreciation.

Of our three contestants, Microsoft operated with the widest profit and operating margins, while ADP contended with the narrowest.

• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control and from the equity invested into the company by shareholders.

For their managerial performance, Cognizant's management team delivered the greatest return on assets while ADP's team delivered the greatest return on equity, with the same teams reciprocating the worst returns.

• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.

Of the three companies here compared, Microsoft provides common stockholders with the greatest diluted earnings per share gain as a percentage of its current share price, while ADP's DEPS over current stock price is lowest.

• Share Price Value: Even if a company outperforms its peers on all the above metrics, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value comes under scrutiny, as well as the stock price relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.

Among our three combatants, Microsoft's stock is the cheapest relative to forward earnings, while Cognizant's is the cheapest relative to company book value and five-year PEG. At the overpriced end of the spectrum, ADP's stock is the most overvalued relative to earnings and book, while Microsoft's is the most overpriced relative to PEG.

B) Estimates and Analyst Recommendations

Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.

• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.

Of our three specimens, Microsoft offers the highest percentages of earnings over current stock price for all time periods, while ADP offers the lowest percentages for all periods.

• Earnings Growth: For long-term investors this metric is one of the most important to consider as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.

For earnings growth, Cognizant offers the greatest growth rate in most time periods, while Microsoft offers the least growth percentage in most periods, with some shrinkage in the current quarter.

• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.

For their high, mean and low price targets over the coming 12 months, analysts believe Cognizant's stock offers the greatest upside potential and least downside risk, while ADP's offers the least upside and Microsoft's offers the greatest downside.

• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up is analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.

Of our three contenders, Cognizant is best recommended with 9 strong buys and 12 buys representing a combined 87.50% of its 24 analysts, followed by Microsoft with 5 strong buy and 10 buy recommendations representing 42.86% of its 35 analysts, and lastly by ADP with 4 strong buy and 4 buy ratings representing 33.33% of its 24 analysts.

C) Rankings

Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.

In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.

The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.

And the winner is… Cognizant by judicial cognizance, outperforming in 14 metrics and underperforming in 5 for a net score of +9, followed by Microsoft, outperforming in 14 metrics and underperforming in 10 for a net score of +4, with ADP trailing way behind, outperforming in 3 metrics and underperforming in 17 for a net score of -14.

Where the Business Software and Services industry is expected to outperform the S&P broader market this quarter, underperform significantly next quarter, then outperform significantly in 2015 and beyond, the three largest U.S. companies in the space are seen split performing, with Microsoft underperforming for the most part, Cognizant outperforming for the most part, and ADP transitioning from underperforming to outperforming in as much as earnings growth is concerned.

Yet, after taking all company fundamentals into account, Cognizant Technology Solutions stands first among its peers given its lowest stock price to company book and five-year PEG, lowest debt over market cap, highest current ratio, highest return on assets, highest trailing earnings growth, highest future earnings growth overall, best price targets, and most analyst strong buy and buy recommendations - handily winning the Business Software and Services industry competition.

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