Recent Selloff Makes Cognizant A Buy

Alex Pickrell profile picture
Alex Pickrell


  • Cognizant's stock has witnessed a brutal selloff, from ~$80 a year ago to $64.24, due to slipping margins and weakness in Cognizant's two largest business segments.
  • This selloff means Cognizant is currently trading at around 16 times forward earnings, historically low for the company.
  • Management's focus on margin improvement and investment in Cognizant's two fastest growing business segments will drive long-term success for the company, making Cognizant attractive at current levels.

Cognizant Technology Solutions Corporation (NASDAQ:CTSH) is currently trading at $64.26 per share, down from a 52-week high of $77.87 primarily due to a weak Q1, followed by an unremarkable Q2. This pullback offers an attractive opportunity for entry into a company poised to benefit from the rise of AI and increased usage of big data analytics across all industries.

Cognizant is a provider of digital, technology, and consulting services.

Source: 10-K

The company’s services are provided to the four primary industries shown above: Financial Services, Healthcare, Communication, Media, and Technology, and Products and Resources.

Services provided to these industries include application development and testing, system integration, infrastructure services, and business process services. For digital services, Cognizant offers analytics and AI solutions, as well as cloud services.

Industry Overview

According to Grandview Research, the global software consulting market is expected to grow at a CAGR of 11.8%, making it one of the faster growing segments in the economy. This growth is driven primarily from the increased trend toward data analytics and cloud computing for companies worldwide.

Growth is also expected to be driven in part by the increased demand for cybersecurity applications and solutions due to an increasing number of cloud-related cyber attacks as of late.

While the IT consulting industry encompasses a wide variety of solutions and technologies, Cognizant laid out their focus going forward on the Q2 conference call; data engineering, cloud, and IoT solutions.

This is likely a wise strategic move for Cognizant, as solutions across these three groups are highly in-demand and likely to continue to be desired for the foreseeable future.

A Rough First Half to 2019

After years of strong growth, Cognizant stumbled significantly in the first half of 2019. Declining margins driven by an increasing cost of revenue has left many investors rightly concerned, as gross margins have declined nearly 400 basis points from 2014, from 40.2% to managements full year guidance of 37% for full-year 2019.

To CEO Brian Humphries credit, he made no excuses during the conference call, saying:

While we are pleased that we met our revenue and margin guidance, we are not satisfied with this level of performance. Our second quarter results do not reflect what Cognizant is capable of achieving in this market environment, neither on revenue growth nor margin rate.

Source 10-Q

Revenue was up around 4.2% from the first six months in 2018. This is significantly lower than the growth rate Cognizant has seen over the past few years. Combined with a gross margin decline of around 230 basis points YoY, from 39.2% in 2018 to 36.9% in 2019, this starts to look worrisome.

The main cause of the underperformance for the first half of 2019 comes from weakness in Cognizant’s two largest business segments: Healthcare and Financials.

Source: Investor presentation

As seen from the graphic above, the Financial Services segment saw a YoY increase of 0.3% while the Healthcare segment declined 1.9%.

Management attributed weakness in the Healthcare was the result of several large clients involved in mergers, negatively impacting revenue. Management expects this to continue throughout Q3 and begin to subside in Q4.

On a brighter note, the Life Sciences segment of the Healthcare vertical saw another quarter of double-digit growth YoY, as momentum for services such as digital operations and other industry specific platforms remains strong.

Cognizant’s offerings in this area are further strengthened by the recent acquisition of Zenith Technologies in July, which provides automation and IoT services in the Life Sciences space.

For the Financial Services segment, weakness was primarily caused by a lack of increased spend across the segment, as recent market conditions have created a level of cautiousness amongst financial clients. Management expects this to continue throughout the second half of FY19.

The weakness in these two segments overshadowed continued strength in Cognizant’s smaller two segments: Products and Resources, and Communications, Media, and Technology.

Products and Resources grew 12.3% in constant currency YoY, marking the sixth straight quarter of double-digit revenue growth. Cloud and digital engineering services led the charge, accompanied by an increased demand for interactive, IoT and analytical solutions.

Communications, Media, and Technology saw constant currency growth of 14.1% YoY, driven by an increasing demand for digital content solutions. While management expects this to moderate slightly for the second half of 2019, it is still expected to remain strong.

Over time, Products and Resources as well as Communications, Media, and Technology are likely to gain share relative to Healthcare and Financial Services, as demand for Cloud, Digital Engineering, IoT, and digital content solutions remains consistently strong.

Going forward, management has stated their intention to continue implementing cost-reduction measures designed to improve margins, including slowing the pace of new hires, improving SG&A expenses, and simplifying the organizational structure. These improvements are likely to start appearing in Q3 and Q4 of 2019.

Long-term Growth

Source: FY18, FY16 10-K

While it is easy to get caught up in Cognizant’s relative weakness for the first half of 2019, it is beneficial to take a longer-term view to see the full picture.

From FY14 to FY18, Cognizant grew revenue at a CAGR of 11.96%, from $10.3 billion to $16.1 billion. EBITDA grew at a CAGR of 11.83%, from $2.1 billion to $3.3 billion, while pre-tax income has grown at a CAGR of 9.8%. This represents exceptional growth, especially for a relatively mature company such as Cognizant.

For FY19, revenue is expected to be somewhere in the range of $16.75-$16.9 billion. Given Cognizant’s revenue of $12.4 billion in 2015, this represents a five-year revenue CAGR of 7.8-8%, should management be able to meet expectations. While this is significantly lower than the five-year number from above, it should stay somewhere between 7-9% going forward.

This is because even if weakness in Financial Services and Healthcare drags on, continued double-digit growth in Communications, Media, and Technology as well as Products and Resources will lead to an overall increase in the YoY revenue growth rate, as they continue to comprise a larger portion of total revenue.

Going forward, management’s efforts to reduce expenses to improve margins should drive bottom-line growth at a similar rate.

Balance Sheet/Valuation/Dividend


Despite strong historical growth, Cognizant’s weak first half of FY19 has seen the company’s stock plummet to a historically low valuation.

With management projecting adjusted diluted EPS for FY19 to be somewhere in the range of $3.92 to $3.98, CTSH is current trading at between 16.1-16.4 times FY19 earnings. This is remarkably cheap for a company that has traded above 20 times earnings for most of the last 9 years.

Source: 10-Q

Cognizant’s balance sheet remains more than healthy, as $1.66 billion in cash and $746 million in outstanding debt means the company has negative net debt.

Current assets of $7.2 billion compared to current liabilities of $2.82 billion gives Cognizant a current ratio of 2.55, further confirming the strength of the balance sheet.

This has and will continue to allow Cognizant to increase shareholder value through acquisitions and share buybacks. YTD, Cognizant has repurchased ~$1.8 billion in shares, and currently has ~$700 million left in the authorized repurchase program.

Cognizant started paying an annualized dividend of $0.60 per share in 2017, which was hiked 33% in 2018 to $0.80 per share, where it has remained since. This equates to a current yield of around 1.25%. With expected 2019 EPS of $3.92-$3.98, the payout ratio for FY19 is under 20%. This gives plenty of room for Cognizant to increase the dividend going forward.


While Cognizant's management has laid out their plan to increase margins going forward, there is no guarantee they will be able to accomplish their goal. Should margins continue to keep slipping, prolonged weakness in the Financial Services and Healthcare segments becomes much more of a problem. While growth has remained strong in the Communications, Media & Technology and Products & Resources segments, there is no guarantee this will continue going forward. Additionally, the IT consulting industry is extremely competitive, with relatively low startup costs and few barriers to entry.

While the current low valuation of Cognizant and future growth potential make the current risk/reward profile attractive, investors should still be aware of the risks to the bull thesis that could cause a further decline in share price.


Despite a weak first half to 2019, Cognizant’s product and service offerings are well aligned with future growth trends, including IoT, data analytics/AI, and digital services. Managements decision to focus investment in these areas going forward will likely pay off for Cognizant, as they outweigh continued weakness in the Financial Services and Healthcare segments. While it remains to be seen whether management’s plan to improve margins will be successful, Cognizant’s current valuation of ~16 times forward earnings makes it one of the more attractive stocks in the technology sector.

This article was written by

Alex Pickrell profile picture
High-Yield, Fixed-Income, Dividend-Growers and Covered-Calls

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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