Cognizant Is an Undervalued Opportunity

The IT consultancy company is poised to ride the digital transformation wave

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Jun 12, 2022
Summary
  • Cognizant is a large IT consultancy which employs over 340,000 people globally. 
  • The stock is currently undervalued relative to history and consultancy peers. 
  • Ray Dalio's Bridgewater Associates was buying shares in the first quarter. 
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Cognizant Technology Solutions Corp. (

CTSH, Financial) is a leading information technology consultancy company.

Founded in 1994, it is part of the Fortune 500 and has a market cap of $38 billion. Since its initial public offering in 1998, the stock has risen by a blistering 35,000%. The share price has had a 19% pullback since March, however.

Prior to this,

Ray Dalio (Trades, Portfolio)'s Bridgewater Associates, which is the world's largest hedge fund, was buying shares in the first quarter. It paid an average price of $87 share. The stock price is now down 16% from those levels. 1533727518828339200.png

Let’s dive into the business model, financials and valuation to determine if it could be a good investment opportunity.

Business model

Like any consultancy company, Cognizant's “people are their product.” It employs an army of 340,000 people globally.

Widely known for helping enterprises with their "digital transformation," the company's services include artificial intelligence, cloud enablement and intelligent process automation. Its customers span across industries, but is known for its focus on pharmaceutical companies and banks. Clients include the top 30 global pharmaceutical companies and nine of the top 10 European banks. These industries make up a large swath of the company’s revenue, which is primarily derived from North America.

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Source: Congizant presentation.

Cognizant has been taking a growth via acquisition strategy, acquiring a plethora of companies in the technology industry. It has acquired a variety of companies such as smaller software consultancies and product development businesses. Through these acquisitions, it has gained client relations and, most importantly, skilled technology employees, which are in high demand.

Steady financials

Cognizant released its earnings for the first quarter of 2022 on May 4. Revenue increased 9.7% year over year, while adjusted earnings per share increased slightly from 97 cents to to $1.08.

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As a service business, the company's gross margin is fairly standard at 37%, while the operating margin is healthy at 15% due to the high markups which can be charged for IT consultancy services.

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The company’s cash flow has increased substantially from $181 million in the first quarter of 2021 to $306 million for the second quarter of 2022. Cash flow per share has also expanded to a healthy $4.

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The company continued to return cash to shareholders in the first quarter with a $771 million share buyback and a $509 million dividend distribution, at a 1.71% yield. Cognizant has reduced its debt substantially over the past couple of years, from $2.4 billion in the first quarter of 2020 to just $655 million by 2022. It is in a strong cash position with approximately $2.7 billion in cash and short-term investments.

In terms of valuation, shares are trading at a price-earnings ratio of 17.64, which is at the low end of historic levels.

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It is also trading at a lower price-earnings ratio than competitors in the industry, such as consulting giant Accenture PLC (

ACN, Financial), International Business Machines Corp. (IBM, Financial) and SAP SE (SAP, Financial).

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The GF Value Line also indicates the stock is modestly undervalued at current levels.

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Final thoughts

Cognizant is a solid company that is poised to ride the growth in digital transformation and software.

The share price has pulled back substantially over the past couple of months and the stock is now undervalued relative to its history and industry peers. I can imagine the company will face pressure from rising wages as high-salaried tech workers are their primary product. However, all consultancy companies will be facing the same issue and, thus, the price may be able to be passed on to customers.

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Disclosures

I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
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