Contemplating Cognizant (CTSH)
November 19, 2009
This year, Forbes, Business Week and Fortune magazines all have recognized Cognizant Technology Solutions (CTSH) as an outstanding growth company. Wikipedia mentions six, noteworthy achievements:
- In 2009, CTSH ranked #7 on Forbes’ 25 Fastest Growing Tech Stocks, #31 on BusinessWeek’s Top 50 Companies, #51 on BusinessWeek’s 100 Hottest Tech Companies, #90 on Fortune’s 100 Fastest Growing Companies (seventh consecutive year on the list), #716 on the Fortune 1000, and was also listed on Forbes’ The Global 2000 (no rankings, Software and Services Industry). [See footnote 1 for URLs]
COMPANY BACKGROUND:
- CTSH is a global information technology, consulting and outsourcing services company headquartered in New Jersey, with some 50 IT or development centers worldwide, and with most of its 62,000 employees in India.
- According to its latest Annual Report, CTSH is organized into four segments and its 2008 revenue was: 46% from financial services (up 28%), 24% from healthcare services (up 36%), 16% from retail/manufacturing/logistics (up 38%), and 14% from communications and other high tech. About 79% of its total revenue came from customers located in North America.
- Morningstar thinks CTSH’s business model provides a competitive advantage because its management is based in the U.S. and key employees are located on-site. In 2008, Cognizant had some 565 customers (up from 500 in the prior year and 400 two years ago), with 12,000 of its employees based in North and South America and 2,700 in Europe.
- With either Hemscott or S&P data, sales growth has been spectacular averaging more than 47% per year over the last 10, 5 and 3 years, and EPS growth more than 41% over the same periods.
** Growth has slowed: last year’s annual Sales were 32% and EPS was 25% (Hemscott) or 26% (S&P).
** Growth in Quarter 3 was up a solid 16% Sales and 18% EPS (so far only reported by S&P) while Q2 growth was up 13% Sales and over 34% EPS (both S&P and Hemscott).
- Value Line’s latest report concluded that CTSH’s stock price has risen over 115% since the start of 2009, and over 15% since its August report, and now offers limited price appreciation over the next 3-5 years.
COMPANY FINANCIALS:
- VL rated Cognizant an “A” for Financial Strength with no debt and almost $1 B in cash assets. Morningstar said much the same.
- The one-click Annual Report spreadsheet by Bob Adams gave Cognizant’s 2008 A.R. a 44 out of 100 with 9 Bullish and 6 Bearish results:
** The 9 Bullish or good things included: Sales are increasing and are increasing faster than related costs, no long-term debt, and gross profit margin is growing;
** The 6 Bearish or not-so-goods included: Accounts Receivable are increasing, free cash flow growth is less than sales growth, and shares outstanding are increasing.
DISCUSSION:
The following table compares the SSG by BudS, which I got from Better Investing’s First Cut page, with two of mine and with Take Stock. The only difference between my two SSGs is that Armin-1 uses Hemscott-Morningstar data from the StockCentral website (like Bud did) while Armin-2 uses S&P data from the BI website.
After the table, I discuss issues identified by the comparison and, once again, ask some questions that I hope you’ll respond to (there are no “right” answers).
| Cognizant Technology (CTSH) | BudS | Armin-1 | Armin-2 | Take Stock |
| Date | 10-7-09 | 11-13-09 | Same | Same |
| Data | Hemscott-Morningstar | Hemscott-Morningstar | S&P | Hemscott-Morningstar |
| Price | $39.47 | $44.77 | Same | Same |
| 52 week High & Low Price | $39.61 & $14.38 | $44.77 & Sane | Same & Same | Not Included |
| Last Q of Reported Data Ending on | Q2 ending 6-30-09 | Q2 ending 6-30-09 | Q3 ending 9-30-09 | Same |
| Software Used | TK 6 | TK 5 | Same | TS Online |
| Project Growth From End of | Last Q | Same | Same | Last FY |
| Sales Growth | 15.00% | 16.00% | Same | 20.00% |
| EPS Growth | 15.00% | 16.00% | Same | 20.00% |
| High PE | 33.3 | 25.5 (from 2008) | 25.8 (from 2008) | 30.0 |
| High EPS | $3.23 | $3.37 | $3.53 | $3.59 |
| High Price | $107.60 (65% > VL on 8-21-09) | $85.90 (32% > VL) | $91.10 (40% > VL) | $107.70 (65% > VL) |
|
Value Line Estimated High Price = $40-65 on 8-21-09 and $50-75 on 11-20-09 |
||||
| Low PE | 22.4 | 10.2 (from 2008) | 10.0 (from 2008) | 17.7 |
| Low EPS | $1.15 (from 2007) | $1.60 (ttm) | $1.68 (ttm) | $1.58 |
| Low Price | $17.30(“other” option) | $16.30 (low PE x low EPS) | $16.80 (low PE x low EPS) | $22.07 (low PE x low EPS) |
| Upside/Down | 3.1 | 1.4 | 1.7 | 3.9 imputed |
| Total Return | 22.2% | 13.9% | 15.3% | 22.3% |
| SSG Buy Under | N/A | $33.70 | $35.38 | $41.98 |
| RV/PRV (no outs) | 70.7/61.6 | 80.2/69.3 | 85.3/73.6 | Not Included |
| Quality | Not Included | Same | B+ | 3.2 unacceptable |
| PTPM – 5 yr ave | 19.8% trend down | Same Same | Same Same | 19.8% Same |
| ROE – 5 yr aveEnd Equity | Not Included | 21.5% trend even | 21.0% trend even | Not Included |
| ROE – 5 yr aveStart Equity | 31.1% trend down | Same Same | 30.5% trend down | 31.2% trend down |
| Debt to Equity –5 yr ave | -0- trend even | Same Same | Same Same | Not Included |
Data Differences:
- CTSH ended its last quarter on 9-30-09, but that data is only reported by S&P at this time. This doesn’t happen often, but is something to be aware of because the choice of SSG data from either Hemscott or S&P can make a noticeable difference whenever we project growth from the last quarter (as I usually do).
- My SSGs were done 5 weeks after Bud’s and, in the interim, CTSH’s price rose 15% to a 52-week high. I hope he bought it below $40 per share.
Estimating Future EPS Growth:
(A) Bud estimated 15.00% EPS growth and his First Cut write-up explained that he was being conservative “since few companies average over 15% over the long haul.”
** CTSH is, in fact, one of those exceptional companies and its historic EPS growth has averaged much more than 15% over the long haul: 40.5% over the last ten years; 42.5% over the last five; 32.8% over the last three; and 25.0% last year, it’s lowest ever (all with Hemscott data which Bud used).
(B) The seven analysts I always check for every SSG were estimating long-term EPS at an average of 20.03% with Value Line high at 28.50% and FactSet via Morningstar low at 17.30%. Reuters and FactSet CallStreet via CNNMoney were both 18.00%, Zacks was 18.14%, S&P was 20.00%, and Thomson-Reuters via Yahoo Finance was 20.30%.
** The consensus of the 8 analysts at FactSet CallStreet ranged from a high of 20.0% to a low of 12.0% as did the 9 analysts at Reuters. And, without Value Line’s estimate of 28.50%, which looks like an outlier to me and which didn’t change in its 11-20 report, the average of the six other analysts dropped to 18.62%. That average less 1 Standard Deviation equals 17.40% and less 2 SDs = 16.18%.
** I projected 16.00% EPS growth based on the analyst average without VL less 2 SDs which, I think, is a conservative approach based on reason. My 16% estimate is not much different than Bud’s 15%, but at least I’m relying on a rational method, not my gut feelings, and also learned what’s unduly conservative or excessive. For example, I thought the 12.0% low estimates at FactSet Call Street and at Reuters were too low by comparison.
** For how I estimate EPS for all my SSGs, see: Estimating EPS
(C) Take Stock used 20.00% EPS which is the highest it will ever estimate for any company no matter how high its actual growth. In this regard, Take Stock is like Bud as both set (arbitrary) limits on future growth that are unrelated to the company’s actual growth.
Forecast High and Low PEs:
(A) Bud did not explain, but his 33.3 Forecast High PE seems to be based on eliminating the three years 2004-2006 and his 22.4 Forecast Low PE on eliminating the 2 years 2004-2005.
(B) I saw that CTSH’s High and Low PEs were trending down and used 2008, the lowest in the last five years, as my Forecast High and Low PEs (25.5 and 10.2).
(C) Take Stock used 30.0 as its Forecast High PE, isn’t designed to look for trends, and always uses a two-step methodology:
** TS first eliminates the five highest High PEs in the last 10 years and averages the rest. It then limits High PEs to 1.5 times its estimated EPS growth or, in this case, to 30.0 (1.5 x 20.00 = 30.0) which is the maximum it will ever forecast no matter how high the company’s actual PEs. A 30.0 High PE is equivalent to a 1.5 High PEG maximum.
** TS used 14.7 as its Forecast Low PE which came from eliminating the five highest Low PEs in the last 10 years and averaging the rest. If that average was more than 20.0 (not the case here), TS would limit the Low PE to a Low PEG of 1.0 max (1.0 x 20.00 = 20.0).
Forecast High Price:
(A) With his 15.00% estimated EPS and 33.3 High PE, Bud got $107.60 for his Forecast High Price which was a whopping 65% greater than the high end of Value Line’s estimated $40-65 High Price on 8-21-09 and 43% greater than VL’s updated $50-75 estimate on 11-20-09.
** That’s way too high for me and I never want to substantially exceed VL’s estimate; see: Determining What’s Reasonable and What’s Not: An Update
(B) With my 16.00% estimated EPS and 25.5 High PE, I got $85.90 for my Forecast High Price which was 32% greater than VL (and only 14.5% greater than VL’s updated estimate).
** 32% is usually too high for me and I prefer to be no more than 20-25% higher than VL. Because both of my SSGs did not statisfy the Buy criteria (UD >3.0 and TR >15%), there was no point to lower my judgments.
(C) With its 20.00% estimated EPS and 30.0 High PE, Take Stock got $107.70 for its Forecast High Price which, like Bud, was also a whopping 65% greater than the high end of Value Line’s estimated High Price of $40-65 and also 43% greater than VL’s updated estimate.
Forecast Low Price:
(A) Bud inexplicably reduced his Forecast Low EPS to 2007’s $1.15 and then disregarded the Low EPS x Low PE option, which is most appropriate for growth companies like CTSH, and decided to use $17.30 which he also did not explain.
(B) & (C) Take Stock and I used the same method (Low PE x Low EPS), but got much different results because TS used a much higher Low PE than I did (17.7 vs 10.2).
Quality:
(A) Bud and Armin-1 used Hemscott-Morningstar data which does not provide any Quality rating.
(B) Armin-2 used S&P data and gave Cognizant a B+ Quality rating which ranked fourth out of its 8 ratings.
(C) Although Take Stock gave Cognizant high marks for its recent and historic growth, CTSH’s downtrend in PTPM resulted in an overall Quality rating of 3.2 which is unacceptable. TS requires a 3.4 minimum to pass muster and a 6.7 is desired.
Pretax-Profit Margin (PTPM) and Return on Equity (ROE):
- Cognizant’s five-year average PTPM of 19.8% is trending down which usually is a red-flag warning sign. However, CTSH is better than its Industry Average of 16.7% (Business Software & Services, Hemscott data) and ranks 14th out of 135 companies.
- Cognizant’s five-year average ROE of 21.5% is also trending down. But, that is far less than CTSH’s industry average of 78.3% which is substantially distorted by 5 companies with ROEs over 100%. Nevertheless, CTSH still ranks 15th out of 135 despite the distorted average.
- For more on using Industry Information to inform our SSGs, see: Investigating Industry Info
Questions:
(1) Are you bothered by Cognizant’s PTPM and ROE downtrends, or does my assessment satisfy you that they are not red-flag warning signs of potential trouble? If you’re not satisfied, what else would you want to look at??
(2) CTSH has excellent Sales and EPS growth (both historic and expected), but does not satisfy the SSG’s minimum BUY criteria of a 15.00% Total Return and a 3.0 Upside/Downside Ratio.
At this time, would you buy Cognizant based on my SSG with its 13.9% TR and 1.4 U/D? Would you have bought it based on Bud’s SSG with a 22.2% TR and a 3.1 U/D??
I like CTSH a lot and have followed it for several years; see: Two Small Company Stocks: Cognizant Technology Solutions (CTSH) and Jack Henry and Associates (JKHY), September 5, 2006 (CTSH is no longer considered a small company).
- Armin
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Footnote 1:
Forbes 25 Fastest Growing Tech Stocks (#7 in 2009), http://www.forbes.com/forbes/2009/0216/048b.html
BusinessWeek’s Top 50 Companies (#31 in 2009), http://images.businessweek.com/ss/09/03/0326_bw50/21.htm
BusinessWeek’s Hottest Tech Companies in 2009 (# 51), http://images.businessweek.com/ss/09/05/0521_IT_100/52.htm
Fortune 100 Fastest Growing Companies (seventh consecutive year, #90 in 2009), http://money.cnn.com/magazines/fortune/fortunefastestgrowing/2009/snapshots/90.html
Fortune 1000 (#716 in 2009), http://money.cnn.com/magazines/fortune/fortune500/2009/full_list/701_800.html
Forbes The Global 2000 (no rankings, 2009 Software & Services Industry) , http://www.forbes.com/lists/2009/18/global-09_The-Global-2000-Software-Services_9Rank.html
Determining What’s Reasonable and What’s Not: An Update
July 15, 2009
[AF: In this update, I've added a substantial amount of new material, indicated in blue italics, on how to determine if our SSG Forecast High PEs and High Prices are reasonable. My original post was published on July 14, 2008 and focused on how to determine if our SSG Sales and EPS estimates were reasonable. As always, let me know what you think.]
Every SSG must make several judgments about the future, the most important of which is estimating the growth of earnings per share for the next 5 years. Estimating Sales growth is also important, especially when it is used to derive EPS growth as part of the BI/NAIC Preferred Procedure.
How do we determine what’s reasonable and what’s not? The answer is easy to express (by comparisons) but much more complex to explain. Consider this concrete example:
Is it reasonable to estimate 24.0% Sales growth for the next 5 years for Cognizant Technology Solutions (CTSH)? Is 21.4% EPS growth reasonable? How do we decide?
In the August 2008 issue of Better Investing magazine, guru Cy Lynch SSGed CTSH using S&P data. Cy found that Cognizant had Sales growth of 48.4% per year during the last 10 years, “the highest rate in the IT services and consulting industry.” His SSG also showed that CTSH averaged an even higher EPS growth rate, a whopping 49.6% annually, during the same 10 year period.
Moreover, over the last 5 years, CTSH’s annual growth rates actually increased to 55.3% Sales and 50.7% EPS. So what do you think is a reasonable estimate for CTSH’s future growth in the next 5 years?
Here is Cy’s answer: “…applying arbitrary limits to projected growth in your stock studies under the guise of being conservative can lead to missed opportunities. I find estimated revenue growth of 24 percent to be reasonable.” [emphasis added]
DISCUSSION
(A) Determining if our SSG Sales and EPS Estimates are Reasonable:
- Cy asserts that a 24.0% estimate for Sales growth is reasonable, but marshals no evidence to support his claim. He does say that Sales grew by an “exceptional 48.4 percent over the last 10 years,” which on its face would seem to support a substantially higher estimate. However, Cy makes no effort to explain why he is estimating so much less than the company’s historical average or why he chose 24.0%.
- For CTSH, Morningstar is estimating 32.10% Sales growth for the next 5 years and Zacks is estimating 55.66%. Cy’s 24.0% estimate is conservative by comparison even though it is greater than the 20.0% maximum advocated by some other BI gurus.
- When I looked on July 12th, the analysts were estimating long-term EPS at around 28-29% with FactSet CallStreet low at 27.00% and Zacks high at 29.86%. S&P was 28.00%, FirstCall was 28.49%, Value Line was 28.50%, and Reuters via Morningstar was 29.00%. There were six estimates at FactSet which ranged from 32.0% to 20.0% low while the seven estimates at Zacks ranged from 49.0% high to 20.0% low.
- When I looked on July 12th, the analysts were estimating long-term EPS at around 28-29% with FactSet CallStreet low at 27.00% and Zacks high at 29.86%. S&P was 28.00%, FirstCall was 28.49%, Value Line was 28.50%, and Reuters via Morningstar was 29.00%. There were six estimates at FactSet which ranged from 32.0% to 20.0% low while the seven estimates at Zacks ranged from 49.0% high to 20.0% low.
- When I looked again almost one year later on June 29, CTSH had fallen in price by -22% and the analysts had lowered their long-term EPS estimates to an average of 21.78% (down from 28.48%) with First Call low at 18.17% (down from 28.49%) and Value Line high at 28.50% (unchanged).
- Thus, 20.0% EPS is the very lowest estimate by any of these analysts and Cy’s 21.4% estimate seems conservative by comparison, especially compared to the 28-29.0% consensus analyst estimate.
- Thus, 20.0% EPS is the very lowest estimate by any of these analysts and Cy’s 21.4% estimate seems conservative by comparison, especially compared to the 28-29.0% consensus analyst estimate.
- Cy derived his 21.4% estimated EPS from BI’s Preferred Procedure (PP) which involves making four estimates for the next 5 years: Sales Growth, Pre-Tax Profit Margin, Tax Rate, and Shares Outstanding. To get his 21.4% estimate, Cy estimated 24% Sales Growth, 19.2% PTPM, 25.0% Tax, and 300M Shares.
- Certain tax breaks that CTSH receives from the Indian government are ending and Cy’s 25% Tax Rate estimate is close to Value Line’s 24% estimate in the next 3-5 years and identical to Morningstar’s estimated long-term tax rate of 25%.
- Cy wrote that his 300M Shares Outstanding was based on VL’s estimate, but VL was actually estimating 288M Shares Outstanding as per its 5-23-08 report. If Cy had used that number, his EPS estimate would have increased from 21.4 to 22.4%.
- Cy also used a Net Profit Margin of 14.3%, but did not explain how he converted that to get the Pre-Tax Profit Margin for his PP. One way is to use this formula [NPM/ (1-Tax Rate)] which works out to 19.1% PTPM. I also worked backwards from all his other factors to get 19.2% which is a slight decrease from 2007’s 19.4% and 5-year average of 20.2%. PTPM has been trending down for the last 5 years.
(B) Determining if our SSG Forecast High PEs and High Prices are Reasonable:
- Our starting point is: High PE x High EPS = High Price. When PE trends are not obvious or I know next to nothing about the stock, I most often begin by choosing a Forecast High PE using Toolkit’s Alt-M command. Alt-M is an undocumented feature that averages the five lowest High PEs (and Low PEs) in the last 10 years. It is usually the most conservative option.
- Some SSGers like to limit their Forecast High PEs to no more than 1.5 times their EPS growth estimate which is the same as using a PEG of 1.5 while others like to use 2.0 and still others prefer 2.1776 . To me, all such limits are arbitrary and unreasonable as no one number fits all stocks. Worse, there is no authority for a 2.0, 2.5, or 2 point anything High PEG.
- What I do is compare Forecast High Prices for the next 5 years to Value Line’s Estimated High Price for the next 3-5 years. I use a two-part test: (A) Does the SSG High Price substantially exceed or fall below VL’s estimate and, if yes, (B) Do I know of a good reason that supports the SSG’s High Price. If my answer is no to (B), I most likely would revise my SSG judgments.
- You can define “substantially” any way you like as there is no right or wrong for matters of judgment. There is, of course, good and bad judgment. I consider substantial to be 15-20% per share greater (or less) than VL. I consider bad judgment to be ignoring VL. And, good reasons can come from research, reading all I can including, for sure, the company’s latest annual report.
- One nice thing about VL’s High Price estimate is that it is expressed as a range from a low of “X” to a high of “Y”. (VL’s low end is not comparable to the SSG’s Low Price). For me, VL’s estimated High Price range defines what’s reasonable, and what’s unreasonable is anything that substantially exceeds or falls below VL without a good reason.
- For example, VL was estimating a $60-90 High Price for CTSH when Cy did his SSG. I’m comfortable being at the high end of VL’s estimate because I know the company’s growth has been like a rocket ship. If I didn’t know much about the company, then I’d prefer to be at the low end of VL’s estimate.
- Cy’s SSG estimated 21.4% EPS growth for CTSH and a 29.0 Forecast High PE that resulted in a $94.50 Forecast High Price, only $4.50 per share or 5.00% more than VL which, by comparison, seems reasonable to me.
- VL makes a High Price estimate for only about 1700 stocks in its Large Cap edition. Its estimate is for the next 3-5 years which means, as I understand VL, for the next 3 and next 4 and next 5 years. That is, the same estimate is applicable to a three year period. VL’s Small and Mid-Cap edition contains no High Price estimate.
- Keep in mind that VL provides benchmark guidance and is not an iron law. What’s most important, I think, is not to overlook or ignore Value Line’s guidance.
CONCLUSIONS:
- I have two, related quarrels with Cy’s analysis:
(1) his way low Sales and EPS estimates both of which were substantially lower compared to CTSH’s historical growth and to what the analysts were estimating. Because of the way the NAIC/BI Preferred Procedure is structured, a Sales estimate that is way low results in an EPS estimate that is way, way too low; and
(2) I am not content with his unsupported assertion that a 24.0% Sales estimate is “reasonable”: simply claiming that something is appropriate does not make it so.
- I no longer use the PP because it involves too many estimates and too much guesswork for me. I prefer to survey the analysts, ascertain their long-term EPS consensus estimate, and thus learn what is high and what is low. That way, I have some basis to know what EPS estimate is reasonably in the ball park and what is not. See: Pondering the Preferred Procedure.
- Make no mistake, I emphatically agree with Cy that arbitrary limits on our SSG estimates are serious mistakes, but I also insist on having some evidence to support each judgment and any claim of reasonableness.
- Here’s a concluding example that tries to put all this together in the context of assessing the Take Stock analysis of Starbucks (SBUX):
(1) On July 1, 2009, Take Stock was estimating EPS growth for Starbucks at -19.10% for the next 5 years (that’s a negative 19.1%). That low-ball estimate works out to a TS Forecast High Price of $6.90 for the next 5 years with SBUX currently selling at $13.89.
(2) I checked the long-term EPS estimates for SBUX by six different analysts and they averaged 15.97% with S&P high at 19.00% and Value Line low at 10.5%. By comparison, -19.1% EPS growth for the next 5 years seems patently unreasonable;
(3) In contrast to Take Stock’s $6.90 Forecast High Price for SBUX, Value Line is estimating a High Price of $25-35. That means TS’s forecast is an whopping 72% UNDER the low end of VL’s estimate which again seems blatantly unreasonable by comparison.
(4) Take Stock’s Forecast Low Price ($10.01) is higher that TS’s Forecast High Price ($6.90). As a result, TS’s High Price is actually low while its Low Price is actually high. That seems way, way wacky to me.
- Armin
[Ellis Traub, the developer and defender of Take Stock, and frequent poster to the BI Discussion List, is invited to comment on what he thinks is reasonable and what's not.]
Determining What’s Reasonable and What’s Not
July 14, 2008
Every SSG must make several judgments about the future, the most important of which is estimating the growth of earnings per share for the next 5 years. Estimating Sales growth is also important, especially when it is used to derive EPS growth as part of the BI/NAIC Preferred Procedure.
How do we determine what’s reasonable and what’s not? The answer is easy to express (by comparisons) but much more complex to explain. Consider this concrete example:
Is it reasonable to estimate 24.0% Sales growth for the next 5 years for Cognizant Technology Solutions (CTSH)? Is 21.4% EPS growth reasonable? How do we decide?
In the August 2008 issue of Better Investing magazine, guru Cy Lynch SSGed CTSH using S&P data. Cy found that Cognizant had Sales growth of 48.4% per year during the last 10 years, “the highest rate in the IT services and consulting industry.” His SSG also showed that CTSH averaged an even higher EPS growth rate, a whopping 49.6% annually, during the same 10 year period.
Moreover, over the last 5 years, CTSH’s annual growth rates actually increased to 55.3% Sales and 50.7% EPS. So what do you think is a reasonable estimate for CTSH’s future growth in the next 5 years?
Here is Cy’s answer: “…applying arbitrary limits to projected growth in your stock studies under the guise of being conservative can lead to missed opportunities. I find estimated revenue growth of 24 percent to be reasonable.” [emphasis added]
DISCUSSION:
- Cy asserts that a 24.0% estimate for Sales growth is reasonable, but marshals no evidence to support his claim. He does say that Sales grew by an “exceptional 48.4 percent over the last 10 years,” which on its face would seem to support a substantially higher estimate. However, Cy makes no effort to explain why he is estimating so much less than the company’s historical average or why he chose 24.0%.
- For CTSH, Morningstar is estimating 32.10% Sales growth for the next 5 years and Zacks is estimating 55.66%. Cy’s 24.0% estimate is conservative by comparison even though it is greater than the 20.0% maximum advocated by some other BI gurus.
- When I looked on July 12th, the analysts were estimating long-term EPS at around 28-29% with FactSet CallStreet low at 27.00% and Zacks high at 29.86%. S&P was 28.00%, FirstCall was 28.49%, Value Line was 28.50%, and Reuters via Morningstar was 29.00%. There were six estimates at FactSet which ranged from 32.0% to 20.0% low while the seven estimates at Zacks ranged from 49.0% high to 20.0% low.
- Thus, 20.0% EPS is the very lowest estimate by any of these analysts and Cy’s 21.4% estimate seems conservative by comparison, especially compared to the 28-29.0% consensus analyst estimate.
- Cy derived his 21.4% estimated EPS from BI’s Preferred Procedure (PP) which involves making four estimates for the next 5 years: Sales Growth, Pre-Tax Profit Margin, Tax Rate, and Shares Outstanding. To get his 21.4% estimate, Cy estimated 24% Sales Growth, 19.2% PTPM, 25.0% Tax, and 300M Shares.
- Certain tax breaks that CTSH receives from the Indian government are ending and Cy’s 25% Tax Rate estimate is close to Value Line’s 24% estimate in the next 3-5 years and identical to Morningstar’s estimated long-term tax rate of 25%.
- Cy wrote that his 300M Shares Outstanding was based on VL’s estimate, but VL was actually estimating 288M Shares Outstanding as per its 5-23-08 report. If Cy had used that number, his EPS estimate would have increased from 21.4 to 22.4%.
- Cy also used a Net Profit Margin of 14.3%, but did not explain how he converted that to get the Pre-Tax Profit Margin for his PP. One way is to use this formula [NPM/ (1-Tax Rate)] which works out to 19.1% PTPM. I also worked backwards from all his other factors to get 19.2% which is a slight decrease from 2007’s 19.4% and 5-year average of 20.2%. PTPM has been trending down for the last 5 years.
CONCLUSION:
- I have two, related quarrels with CY’s analysis:
(1) his way low Sales and EPS estimates both of which were substantially lower compared to CTSH’s historical growth and to what the analysts were estimating. Because of the way the NAIC/BI Preferred Procedure is structured, a Sales estimate that is way low results in an EPS estimate that is way, way too low; and
(2) I am not content with his unsupported assertion that a 24.0% Sales estimate is “reasonable”: simply claiming that something is appropriate does not make it so.
- I no longer use the PP because it involves too many estimates and too much guesswork for me. I prefer to survey the analysts, ascertain their long-term EPS consensus estimate, and thus learn what is high and what is low. That way, I have some basis to know what EPS estimate is reasonably in the ball park and what is not.
- Make no mistake, I emphatically agree with Cy that arbitrary limits on our SSG estimates are serious mistakes, but I also insist on having some evidence to support each judgment and any claim of reasonableness.
- Armin
Two Small Company Stocks: Cognizant Technology Solutions (CTSH) and Jack Henry and Associates (JKHY)
September 5, 2006
It’s difficult to find good small company stocks that are reasonably priced. One source for leads is Forbes magazine which lists the 200 best small company stocks every year. Small is defined as Sales between $5M and $750M. Companies must also have a net profit margin greater than 5% and a share price greater than $5.00 to make the list. See: http://www.forbes.com/200best
I’ve followed several of these stocks for awhile, two of which are: Cognizant Technology Solutions (CTSH) and Jack Henry and Associates (JKHY). JKHY was also singled-out as part of Forbes’ 14 favorites to buy now [all 14 are listed below]. http://www.forbes.com/free_forbes/2005/1031/171.html
Cognizant Technology
CTSH was #1 of 200 last year (2004) and #2 this year with 4 consecutive years on the list. Cognizant provides custom IT consulting and technology services as well as outsourcing services to companies located in North America, Europe and Asia. CTSH tailors its services to specific industries with IT development centers in India.
Cognizant has been growing like a rocket ship. The current Value Line report (8-25-06) says it has averaged 48.5% EPS growth for the past 5 years and VL is estimating 30.0% EPS growth for the next 3-5 years. Many NAIC gurus think that projecting more than 20% is unsustainable and therefore unwise. That guidance doesn’t seem to fit CTSH….although I am uneasy projecting much more than 20% for the next 5 years, for sure without a lot more research.
As an illustration, I used VL’s estimate of 30% future EPS and a projected High PE of 45.9 based on eliminating 2003, 2004 & 2005 from the historical average PE as atypical outliers. I got a Forecast High Price in the next 5 years of $218.00 which is a whopping $108.00 per share or 98% greater than VL’s estimated High Price of $75-110. I NEVER want to exceed VL by such a humungous amount, even if I have a good reason which I don’t have.
This suggests that CTSH is overvalued, that investors have bid the share price of this high growth company way, way up….by paying any price, but not a reasonable price.
When I project 26% EPS growth (34.18% estimate from Reuters.com less one Standard Deviation of 8.20% which the website provides), I get a Forecast High Price of $186.80 which is still $76.80 per share or 70% greater than VL’s estimate of $75-110. The one Standard Deviation of 8.20% indicates wide variation among the 14 analysts and my reducing the Reuters estimate helps reduce the risk of missing their consensus estimate. However, now CTSH has a Reward/Risk or Upside/Downside Ratio of 2.8 which does not satisfy the SSG reasonable price criteria of 3.0.
Moreover, VL’s prior 5-26-06 report observed that “CTSH has been a favorite of momentum investors, which is evident in the score for Price Growth Persistence” and which was then and currently is 100%. I’m not a momentum investor and I’ll pass on CTSH. One of several reasons is that the current Value Line estimates CTSH’s PE will fall by nearly 40% in the next 3-5 years as its growth slows.
On September 1, 2006, Cognizant was selling for $70.03 per share.
Jack Henry
JKHY was # 99 last year and # 164 this year with 6 consecutive years on the Forbes list. Jack Henry provides integrated computer systems for in-house data processing to banks and other financial institutions. It also installs software, performs data conversion, customizes its software, and provides customer support services.
Jack Henry’s EPS grew 13.5% for the last 5 years and VL is estimating 15.0% for the next 3-5 years. When I use VL’s estimate of 15.0% future EPS and a projected High PE of 27.2 (2005 eliminated as an outlier), I got a Forecast High Price of $52.50 which was slightly under VL’s estimated High Price of $35-55.
I also used $15.40 as my Forecast Low Price which was the lowest option among my software’s four choices. These judgments resulted in a 8.9 Risk/Reward or Upside/Downside Ratio and a 23.2% Total Return which easily satisfy the SSG reasonable price criteria.
If I use 22.5 as my High PE (1.5 times my 15% EPS growth rate), I get a 3.2 U/D and a 18.9% TR which still satisfy the SSG reasonable price criteria.
JKHY’s Pre-Tax Profit Margin has been an average of 22.1% for the past five years and is trending even; Return on Equity has been 16.1% for the same period and is trending down. Fiscal year 2006 data has been reported, but is not yet available from the S&P data service that I use. It will be interesting to see what happens to these trends when 2006 data is made available.
There are other issues to consider before deciding to buy any stock, but at least Jack Henry looks like it is selling at a reasonable price (unlike Cognizant). JKHY, however, had revenues of $535.9M in 2005 which satisfies Forbes definition of small company, but does not satisfy NAIC’s which is revenues under $500M.
On September 1, 2006, Jack Henry was selling for $19.17 per share.
armin
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Forbes’ fourteen favorites are, along with their rank in the 200 list: Advisory Board, #7; Corporate Executive Board, #30; Jack Henry & Associates, #164; FactSet Research Systems, #53; Hydril, #52; Kronos, #125; Mobil Mini, #169; Navigant Consulting, #28; Resmed, #51; Resources Connection, #11; Talx, $158; Waste Connections, #32; and Yankee Candle, #32 (Forbes’ goof).
