Friday, May 27, 2011

Should Your Portfolio Get to Know Cognizant?

Cognizant Technology Solutions (NASDAQ: CTSH) builds computer systems for companies in a unique way. Its business analysts work with clients from offices in the U.S. and other company headquarters countries while its coders write software in India. The result has been rapid growth and high profitability. Should you add Cognizant to your portfolio?

Cognizant's financial performance over the last five years has defied the general economic doldrums in the U.S.,where it's based. In the most recent 12 months, its sales were $5 billion, growing at a 39% five year average rate while its net income accelerated at a 35% annual rate to $791 million. Cognizant's market capitalization of $22.9 billion has skyrocketed 54% in the last year -- more than twice the S&P's 22% gain.

Cognizant plays in a large market that's growing fast. According to India's National Association of Software & Services Companies (Nasscom), the market for information technology outsourcing will grow 17% in 2011 to $76 billion. The fastest growth -- between 1.3 and 1.5 times the industry average will come from financial services -- including banking, financial services and insurance with demand in the U.S. account for the most revenue growth.

Cognizant's performance over the last five years has been great but its first quarter 2011 results disappointed analysts who seemed to be stretching for bad news. After all, Cognizant's Q1 2011 profit of $208.3 million was 38% more than the year before's $151.5 million while revenue grew 43% to $1.37 billion Not only that, but its operating margin widened to 19.4% from 19.1% despite a 52% spike in overhead costs.

Perhaps the problem was that its second quarter forecasts were slightly less than analyst expectations. Cognizant projected EPS of $0.65 cents in the second quarter, a penny below what analysts expected. But its revenue forecast of "at least $1.45 billion" exceeded analysts' $1.44 billion expectation.

But the worst news -- driving its stock down nearly 8% when it announced in early May -- was that some of its financial services business' major merger and acquisition projects in the U.K. are ending. Perhaps analysts were worried that it would be more difficult for Cognizant to beat expectations. Or more likely traders were using the glimmer of negative news -- which should not have come as a surprise -- to take profits.

So should you go add Cognizant to your portfolio? To think about that, we can look at its price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

It's a fairly expensive stock -- trading at a PEG of 1.45. Cognizant's P/E is 29.5 and its earnings are forecast to grow 20.4% to $3.32 in 2012. But it also has a track record of beating expectations -- by an average of 5.2% in the last five quarters.

This company is a very strong player in an attractive industry. I would look at buying it at a lower entry point in the event of a market break. While currently pricey, Cognizant could be a good long-term holding.


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