Cognizant’s Performance Merits Premium Valuations, But Management Isn’t Giving Markets Any Reason To Change Opinions
- Cognizant Technology Solutions Corp. (CTSH) is trading near historical lows relative to both adjusted asset and adjusted earnings value.
- Considering management’s concerns about the sustainability of revenue growth and demand for their solutions, current low valuations and expectations may be warranted in the near term.
- Valuations are similar to peer levels, however CTSH has historically shown substantially stronger growth, spelling potential for longer-term equity upside.
CTSH has seen historically robust, relatively stable profitability, with Adjusted ROA (ROA’) levels ranging from 32%-42% since 2000. Meanwhile, Adjusted Asset (Asset’) growth was fairly aggressive from 2000-2008, ranging from 39%-69%, but has tapered off to 2%-31% levels since 2009.
It can be helpful to break down ROA’ into its DuPont formula parts, Adjusted Earnings Margin (Earnings’ Margin) and Adjusted Asset Turnover (Asset’ Turns), which are the cleaned up margins and turns metrics used to calculate ROA’. The chart below details both Earnings’ Margin and Asset’ Turns historically, to help us better understand the drivers of the firm’s profitability and performance. The detail behind the chart can be found here.
Valuation Matrix – ROA’ and Asset’ Growth as Drivers of Valuation
When valuing a company, it is important to consider more than a singular target price, and instead the potential value of a firm at various levels of performance. The below matrix highlights potential prices for CTSH at various levels of profitability (in terms of ROA’) and growth (Asset’ growth). Prices that are in excess of 10% equity upside are highlighted in black, and prices representing an excess of 10% equity downside are highlighted in red. To see more about the below chart, and also to be able to input your own scenarios to understand how it impacts valuations, please click here.
Click here to read the article in its entirety at Seeking Alpha, where we also included a discussion of Cognizant’s performance and valuation relative to its peers.