Is Cognizant Technology's Growth Sustainable?

I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit that some growth stories are bogus, hence this regular series. We'll be taking a closer look at many of the market's great growth stocks to see which of them show real, numerically relevant signs of sustainability.

Next up in our series is Cognizant Technology (Nasdaq: CTSH  ) , an Indian technology consultancy that was born out of Dun & Bradstreet. Yet, interestingly, 79% of its business comes from right here in North America.

Foolish facts

Metric

Cognizant Technology Solutions

CAPS stars (out of 5)

***

Total ratings

1,045

Percent bulls

95.8%

Percent bears

4.2%

Bullish pitches

152 out of 159

Highest-rated peers

CGI Group, CACI International (Nasdaq: CACI  ) , Lionbridge Technologies (Nasdaq: LIOX  )

Source: Motley Fool CAPS, as of Aug. 31.

Three-star stocks are the ones Fools can't make up their minds about, and there are indeed varying opinions when it comes to Cognizant Technology's business.  

In a recent example, my Foolish colleague Anders Bylund waxed enthusiastic about the stock a day after Foolish investor mopoff wrote that Cognizant Technology, while great, was "due for a correction." Anders says:

Cognizant Technology claims to bend over backwards for its customers, even when it doesn't have to. The proof is in the pudding as the company shows the results to back this claim up. It's the same "fanatical support" mantra that makes Rackspace Hosting an official Rule Breaker. Given the sterling customer focus and lengthy record of success, I'm going with a long-term 'outperform'.

If he's right, I'd be bullish, too. Rackspace's relentless focus on customer service has made it a big winner in our Rule Breakers portfolio, and one of my favorite picks for our scorecard.

The elements of growth

Metric

Past 12 Months

2009

2008

Normalized net income growth

24.9%

23.2%

24.6%

Revenue growth

26.9%

16.4%

31.9%

Gross margin

42.6%

43.6%

44.2%

Receivables growth

46.8%

22.4%

32.8%

Shares outstanding

300.8 million

297.2 million

291.7 million

Source: Capital IQ, a division of Standard & Poor's.

There's good news in this table:

  • As the bold text shows, revenue growth dipped temporarily in 2009 but has since recovered. Net income growth has remained steady.
  • Gross margin also looks stable. That's good news: it suggests competitors aren't killing Cognizant Technology with price cuts.
  • If there's a reason to be concerned here, it's with Cognizant Technology's receivables record. I'm willing to live with it -- for now -- because of how the professional services business works. Clients book time that companies then bill, creating a receivable. Were the gap between receivables and sales growth to widen much further, I'd consider a bearish position on Cognizant Technology.

Competitor checkup

Competitor

Normalized Net Income Growth (3 years)

Accenture (NYSE: ACN  )

5.3%

Cognizant Technology

27.9%

CSC (NYSE: CSC  )

3%

IBM (NYSE: IBM  )

10.9%

Infosys

18.3%

Wipro (NYSE: WIT  )

21.4%

Source: Capital IQ. Data current as of Aug. 31.

This table is far more encouraging. In a business where technical advantages are difficult or even impossible to come by, Cognizant Technology has established itself as the leading grower. Could Anders' references to fanatical service have something to do with that?

Either way, the stock entered the day trading for a reasonable 22 times earnings. Why is that reasonable? Analysts peg Cognizant Technology's long-term earnings growth rate at 17.9%. Today's multiple amounts to a modest premium, at worst.

Grade = sustainable
Between stable margins and predictable net income growth, there's a lot to like about Cognizant Technology. There's no reason to believe this story can't continue as it has.

Now it's your turn to weigh in. Do you like Cognizant Technology at these levels? Would you make it one of our 11 o'clock stocks? Let the debate begin in the comments box below, and when you're done, click here to get today's 11 o'clock portfolio pick.

You can also ask Tim to evaluate a favorite growth story by sending him an email, or replying to him on Twitter.

Accenture is a Motley Fool Inside Value pick. Rackspace is a Rule Breakers recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He owned shares of IBM at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. The Motley Fool is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.


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