Cognizant Technology Solutions meets some but not all of Benjamin Graham's requirements for a defensive stock. The Data Processing Services company does not offer a large enough margin of safety for cautious investors, but it does have many qualities that may interest more enterprising investors.
Cognizant Technology Solutions Is Probably Overvalued
Graham devised the below equation to give investors a quick way of determining whether a stock is trading at a fair multiple of its earnings and its assets:
√(22.5 * 6 year average earnings per share (3.41) * 6 year average book value per share (25.55) = $48.51
At today's price of $66.11 per share, Cognizant Technology Solutions is now trading 36.3% above the maximum price that Graham would have wanted to pay for the stock.
Even though the stock does not trade at an attractive multiple, it might still meet some of the other criteria for quality stocks that Graham listed in Chapter 14 of The Intelligent Investor.
Impressive Revenues, Consistent Profitability, and a Growing Dividend Imply Value
Cognizant Technology Solutions’s average sales revenue over the last 6 years has been $24.55 Billion, so by Graham’s standards the stock has sufficient revenues to make it worthy of investment. When published in 1972, Graham’s threshold was $100 million in average sales, which would be the equivalent of around a half million dollars today.
Ben Graham believed that a margin of safety could be obtained by investing only in companies with consistently positive retained earnings. Retained earnings represent the cumulative net earnings or (deficit) left to equity holders after dividends have been paid out. Cognizant Technology Solutions had positive retained earnings from 2008 to 2022 with an average of $7.68 Billion over this period.
Ben Graham would also require a cumulative growth of Earnings Per Share of at least 30% over the last ten years.To determine Cognizant Technology Solutions's EPS growth over time, we will average out its EPS for 2007, 2008, and 2009, which were $1.15, $1.44, and $0.47 respectively. This gives us an average of $1.02 for the period of 2007 to 2009. Next, we compare this value with the average EPS reported in 2020, 2021, and 2022, which were $2.57, $4.05, and $4.41, for an average of $3.68. Now we see that Cognizant Technology Solutions's EPS growth was 260.78% during this period, which satisfies Ben Graham's requirement.
Cognizant Technology Solutions’s Balance Sheet Meets Graham’s Criteria
It was also essential to Graham that the company’s current assets outweigh its current liabilities, and that its long term debt be inferior to the sum of its net current assets (current assets minus total liabilities). This is the aspect of the analysis that most companies fail, yet Cognizant Technology Solutions passes comfortably, with an average current ratio of 2.2, and average debt to net current asset ratio of 0.4.
Conclusion
Cognizant Technology Solutions offers a decent combination of value, growth, and profitability. These factors imply that the investment offers a decent margin of safety — especially if the shares are bought during a sell-off.
| 2018-02-27 | 2019-02-19 | 2020-02-14 | 2021-02-12 | 2022-02-16 | 2023-02-15 | |
|---|---|---|---|---|---|---|
| Revenue (MM) | $14,810 | $16,125 | $16,783 | $16,652 | $18,507 | $19,428 |
| Gross Margins | 38.0% | 39.0% | 37.0% | 36.0% | 37.0% | 36.0% |
| Operating Margins | 17% | 17% | 16% | 14% | 15% | 15% |
| Net Margins | 10.0% | 13.0% | 11.0% | 8.0% | 12.0% | 12.0% |
| Net Income (MM) | $1,504 | $2,101 | $1,842 | $1,392 | $2,137 | $2,290 |
| Net Interest Expense (MM) | $110 | $150 | $150 | $95 | $21 | $40 |
| Depreciation & Amort. (MM) | -$443 | -$498 | -$526 | -$559 | -$574 | -$569 |
| Earnings Per Share | $2.53 | $3.6 | $3.29 | $2.57 | $4.06 | $4.41 |
| EPS Growth | n/a | 42.29% | -8.61% | -21.88% | 57.98% | 8.62% |
| Diluted Shares (MM) | 595 | 584 | 560 | 541 | 526 | 519 |
| Free Cash Flow (MM) | $2,691 | $2,969 | $2,891 | $3,697 | $2,774 | $2,900 |
| Capital Expenditures (MM) | -$284 | -$377 | -$392 | -$398 | -$279 | -$332 |
| Net Current Assets (MM) | $4,559 | $4,188 | $2,429 | $764 | $1,481 | $1,723 |
| Long Term Debt (MM) | $698 | $736 | $700 | $663 | $626 | $638 |
| Net Debt / EBITDA | -1.43 | -1.14 | -0.84 | -0.7 | -0.6 | -0.52 |
