Information Technology Services company Cognizant Technology Solutions stunned Wall Street today as it surged to $66.11, marking a 7.5% change compared to the S&P 500 and the Nasdaq indices, which logged -0.0% and -0.2% respectively. CTSH is 5.07% above its average analyst target price of $62.92, which implies future downside for the stock. Indeed, the average analayst rating for the stock is hold, showing a rather gloomy outlook. Over the last year, Cognizant Technology Solutions has underperfomed the S&P 500 by 14.7%, moving -29.5%.
Cognizant Technology Solutions Corporation, a professional services company, provides consulting and technology, and outsourcing services in North America, Europe, and internationally. The companyis in the technology sector, which groups together a wide range of industries including consumer electronics, software, computer hardware, scientific instruments and IT services. Legendary investor Warren Buffet once stated that he would never invest in technology companies. Apple is now one of his largest holdings.
The risks inherent to the technology sector are clear, but investors simply cannot ignore the potential for strong returns. Even with the lessons learnt in the 2000 tech bubble, the market continues to highly value the promise of technological innovation and the ability for these companies to build and occupy new markets.
Cognizant Technology Solutions's trailing 12 month P/E ratio is 14.5, based on its trailing EPS of $4.56. The company has a forward P/E ratio of 14.0 according to its forward EPS of $4.73 -- which is an estimate of what its earnings will look like in the next quarter. As of the third quarter of 2022, the average Price to Earnings (P/E) ratio of US technology companies is 26.5, and the S&P 500 average is 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (EPS), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.
Cognizant Technology Solutions's P/E ratio tells us how much investors are willing to pay for each dollar of the company's earnings. The problem with this metric is that it doesn't take into account the expected growth in earnings of the stock. Sometimes elevated P/E ratios can be justified by equally elevated growth expectations.
We can solve this inconsistency by dividing the company's trailing P/E ratio by its five year earnings growth estimate, which in this case gives us a 2.55 Price to Earnings Growth (PEG) ratio. Since the PEG ratio is greater than 1, the company's lofty valuation is not completely justified by its growth levels.
An analysis of the company's gross profit margins can help us understand its long term profitability and market position. Gross profits are the company's revenue minus the cost of goods only, and unlike earnings, don't take into account taxes and overhead. Here's an overview of Cognizant Technology Solutions's gross profit margin trends:
| Date Reported | Revenue ($ MM) | Cost of Revenue ($ MM) | Gross Margins (%) | YoY Growth (%) |
|---|---|---|---|---|
| 2021-12-31 | 18,507 | 11,604 | 37.3 | 3.84 |
| 2020-12-31 | 16,652 | 10,671 | 35.92 | -1.97 |
| 2019-12-31 | 16,783 | 10,634 | 36.64 | n/a |
- Average gross margin: 36.6 %
- Average gross margin growth rate: 0.9 %
- Coefficient of variability (lower numbers indicating more stability): 1.9 %
While not the strongest, Cognizant Technology Solutions's gross margins indicate that its underlying business is viable, and that the stock is potentially worthy for investment -- as opposed to speculative -- purposes.
Another key to assessing a company's health is to look at its free cash flow, which is calculated on the basis of its total cash flow from operating activities minus its capital expenditures. Capital expenditures are the costs of maintaining fixed assets such as land, buildings, and equipment. From Cognizant Technology Solutions's last four annual reports, we are able to obtain the following rundown of its free cash flow:
| Date Reported | Cash Flow from Operations ($ MM) | Capital expenditures ($ MM) | Free Cash Flow ($ MM) | YoY Growth (%) |
|---|---|---|---|---|
| 2021-12-31 | 2,495 | -279 | 2,216 | -23.61 |
| 2020-12-31 | 3,299 | -398 | 2,901 | 37.68 |
| 2019-12-31 | 2,499 | -392 | 2,107 | n/a |
- Average free cash flow: $2,408,000,000.00
- Average free cash flow growth rate: 7.0 %
- Coefficient of variability (the lower the better): 17.9 %
With its positive cash flow, the company can not only re-invest in its business, it can offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in CTSH have received an annualized dividend yield of 1.8% on their capital.
Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts. As of the third quarter of 2022, the average P/B ratio for technology companies is 5.57. In contrast, the average P/B ratio of the S&P 500 is 2.95. Cognizant Technology Solutions's P/B ratio is 2.8, indicating that the market value of the company exceeds its book value by a factor of more than 2, but is still below the average P/B ratio of the Technology sector.
As of third quarter of 2022, Cognizant Technology Solutions is likely undervalued because it has a very low P/E ratio, a lower P/B ratio than its sector average, and a steady stream of strong cash flows that are on an upwards course. The stock has Mixed Growth Prospects because of its consistent operating margins with a stable trend, and a PEG ratio of less than 1. We hope this analysis will inspire you to do your own research into CTSH's fundamental values -- especially their trends over time.
