Number seven on the S&P 500 Screener list for net buys is Cognizant Technology Solutions Corp. (CTSH, Financial), a $28.6 billion IT company. The screener helps us figure out where the investing gurus are putting their money now, and more specifically where they are buying more than they are selling.
What does Cognizant do? In its most recent 10-K, filed on Feb. 14, it provided this description, which we’ll break down to make it easier to grasp:
- “Our clients seek to partner with service providers that have a deep understanding of their businesses, industry initiatives, customers, markets and cultures and the ability to create solutions tailored to meet their individual business needs."
- “Across industries, our clients are confronted with the risk of being disrupted by nimble, digital-native competitors."
- “They are therefore redirecting their focus and investment to digital and embracing DevOps and key technologies like IoT, analytics, AI, digital engineering, cloud and automation.”
- “We believe that our deep knowledge of the industries we serve and our clients’ businesses has been central to our revenue growth and high client satisfaction, and we continue to invest in those digital capabilities that help to enable our clients to become modern businesses.”
Summing up, the firm helps traditional businesses adapt to digital technologies so they won’t be crushed by them. It focuses on four segments: Financial Services, Healthcare, Products and Services (includes manufacturers, retailers and travel and hospitality companies) and Communications, Media and Technology.
It is also a company besieged by controversy, much of it of its own making. Some of that related to its operations in India, but even in America it has had challenges. The allegations include bribery, discrimination, tax evasion and corruption. There are also several accusations that its working conditions were substandard.
For example, Cognizant announced late last year that it planned to exit the content moderation business. That involved reviewing Facebook (FB, Financial) content for inappropriate materials; critics argued the minimum-wage employees doing the work were heavily stressed by the continual violent, obscene and hateful content they reviewed.
Cognizant also has had an encounter with an activist hedge fund. Elliott Management sent a letter to the company in November 2016, arguing that if the company followed its plan it could see a 50% to 69% increase in its share price by the end of 2017.
From the Elliott perspective, the company had failed to get past the small, growth company mindset from 20 years earlier. The firm wrote, “Cognizant’s operations and capital allocation strategies are remnants of its history as a nascent industry “challenger” that invested at all costs to gain share. Today, however, Cognizant has evolved into a scale industry leader, and its business choices must also evolve to reflect this reality.”
Elliott’s Value Enhancement Plan had three prongs:
- Fundamental operational improvements.
- Efficient allocation of capital.
- Effective oversight and incentive alignment.
Management accepted those proposals and Elliott exited its position (made up of shares and derivatives) in 2018 at a profit reported to be around 50%.
This 10-year chart, with the Elliott holding period bracketed by the two vertical black lines, shows the effect the investment firm had on Cognizant’s share price:
Beyond the day-to-day drama, Cognizant has strong ratings for financial strength and profitability. This is the current picture of its financial strength:
Some figures to note:
- The cash-to-debt ratio is above 1.0, signaling the company has enough cash and cash equivalents to repay its debts immediately.
- Interest coverage is very high, suggesting both strong cash flow and a modest level of debt.
- Its return on invested capital is more than double its weighted average cost of capital, meaning it is productively using the equity and borrowed funds it has received.
Its profitability rating is a bit stronger at 9 out of 10.
- It generates double-digit margins, return on equity and return on assets.
- The column of green bars suggests the company is outperforming most of its 2,100 peers in the software industry.
- The column of red bars indicates the company is not doing as well on these metrics as it has in the past. The GuruFocus system generates two severe warnings, one because its gross margin has declined and one for the decline in its operating margin.
Because it has had reasonably consistent earnings (its predictability rating is 3.5 out of 5), GuruFocus is able to reach a discounted cash flow result: It estimates fair, or intrinsic value, at $58.37, compared to its current price of $52.52, providing a 10% margin of safety.
As this chart shows, the investing gurus have been buying more than they have been selling since the first quarter of 2019:
A total of 21 gurus, a relatively high number, have holdings in Cognizant. The three largest holders are Dodge & Cox with 23.7 million shares, Al Gore (Trades, Portfolio) of Generation Investment Management with 16 million shares and Richard Pzena (Trades, Portfolio) of Pzena Investment Management with 8.9 million shares.
Presumably, much of the guru interest in early 2019 came as the stock retreated from the highs registered in early 2018. We can also see a connection between the Covid-19-induced price drop and the spike in guru interest in the past two months.
The stock is popular among institutional investors, a group that includes some of the gurus, with 60.5% of the shares outstanding. Insiders own 0.52%.
Cognizant Technology Solutions was a high-growth, market share-focused company until late 2016, when Elliott Management convinced it to act like a more mature company, one that would begin distributing part of its profits to shareholders.
Elliott’s intervention had the desired effect on the stock price, it shot up. Unfortunately for other stockholders, the price dropped backed when Elliott pulled out (although the price decline began before the activist exited).
It is also a company that carries a lot of baggage, but behind the noise there is a company with solid credentials for financial strength and profitability. Those credentials, along with the decline in prices, has made it an attractive target for the investment gurus.
Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.
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