Every stock is both a winner and a loser, depending on the price you paid. Annual highs and lows are often far apart. Short-term price action is hard to predict, but improving fundamentals can add tremendous value over the long haul which can be measured and evaluated.
Few companies have done as well as Cognizant Technology Solutions (CTSH, Financial) since the start of 2010. Over the past six years Cognizant’s four basic metrics each improved by from 175% to 221%. The stock did well, too, but its 144% split-adjusted rise didn’t quite match the magnitude of the other gains.
That means present-day shareholders are getting a better relative value today. Cognizant’s forward price-earnings (P/E) on Feb. 7, 2010 was 18.3x. On Feb. 7, 2017, the stock was available for just 14.6x Value Line’s 2017 EPS estimate of $3.65.
Note: Cognizant will report fourth-quarter 2016 numbers on Wednesday, Feb. 8.
Cognizant’s impressive growth has been internally financed. As of Sept. 30, 2016, the company held about $4 billion more in cash than it had in total debt outstanding.
Successfully trading Cognizant has been as easy as monitoring its valuation. The stock’s average multiple has been just over 20x. The five best buying opportunities (green-starred below) each occurred at discounted P/Es.
All three “should have sold” moments (red-starred) came at elevated P/Es ranging from 28% above normal to a greater than 54% premium to its typical valuation. Cognizant's most extreme overpricing, in early 2011, made investors wait over two years to get even. Those who exited Cognizant near 2013’s pinnacle could have repurchased the shares for the same price about three years later.
Momentum chasers who didn’t cash out late in 2015 are still underwater.
Recent dull share price action has masked the value buildup from Cognizant’s all-time best results. Throw out the 2010-2011 P/Es as outliers. Cognizant averaged 19.0x earnings over the most recent half-decade. Applying that multiple to this year’s projection supports a 12-month target price above $69.
That very achievable goal is 30% above Tuesday morning’s quote. It’s where Cognizant topped out more than 16 months earlier when sales and profits were lower than today.
At least some option buyers agree that Cognizant can rise to north of $70 over the coming year. I was able to sell some Jan. 19, 2018, expiration date $70 covered calls for $1.25 per share today.
Break-even for the traders who went long that option is $71.25 per share ($70 strike plus $1.25 premium). I’m willing to cap my next 10.5 months’ upside at that level (32%) in order to pocket a synthetic dividend of $1.25 per share (2.32% of Tuesday’s closing price).
Put writers who believe Cognizant looks promising can still get paid for committing to buy at well below its current market price. Extend out to January 2019 to collect around $6.60 on the $50, $9 for the $55 or $12.30 for the currently in-the-money $60 puts.
The forced purchase, “if exercised” prices drop to $43.40, $46 or $47.70. Owning Cognizant at any of those levels appears far from scary.
The most conservative of those entry points would be quite close to the fleeting, absolute lows set during the previous three years. Last September’s sharp selloff to the $45 to $46 range proved to be a fabulous chance to buy Cognizant cheaply.
Disclosure: Long Cognizant shares, short Cognizant options.
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