The IT (Information Technology) services sector includes a wide range of consultancy firms, desktop management companies, data center specialists, network integrators, software support companies, and outsourcing partners. The sector doesn't include data center hardware, enterprise hardware, enterprise devices, or enterprise software -- although IT services are dependent on their sales. Higher sales of data servers, for example, boost demand for data center specialists. Likewise, a decline in sales of enterprise software reduces the need for software support services.
Gartner (NYSE:IT) expects global IT spending to decline 4.9% annually in 2015, compared to 1.5% growth last year, mainly due to currency headwinds. However, Gartner expects the market to return to positive growth in 2016 and beyond. While that might not sound like an ideal sector to invest in, several top IT services stocks have outperformed the broader market this year. Let's take a closer look at two such stocks -- Accenture (NYSE:ACN) and Cognizant Technology Solutions (NASDAQ:CTSH).
Accenture provides management consulting and outsourcing services to various companies across the media, healthcare, financial services, and tech sectors. Compared to IBM (NYSE:IBM), which sells a wide range of IT services, hardware, and software, Accenture is considered a "pure play" on business IT services.
Last quarter, just over half of Accenture's revenue came from consulting, while the rest came from outsourcing services. Consulting revenue rose 14% annually in local currency terms, while outsourcing revenue improved 9%. Accenture's total revenue rose 1.4% annually to $7.98 billion, which beat the consensus estimate by $210 million. Excluding currency impacts, revenue would have improved 12%. By comparison, IBM's Global Technology Services and Global Business Services revenue respectively rose 1% and declined 3% annually last quarter, excluding currency impacts and divestments. On the bottom line, Accenture's net income grew 4% to $788 million, or $1.15 per share, which beat estimates by three cents.
Unfortunately, Accenture's guidance for the first quarter of 2016 spooked some investors. Accenture expects to generate $7.7 billion to $7.95 billion in revenues during the quarter due to a stronger dollar, which missed the consensus estimate of $8.12 billion. For the full year, Accenture expects revenues to rise 1% to 4% annually to $31.3 billion to $32.3 billion, which also fell short of the $32.6 billion consensus estimate. The company anticipates 6% to 9% earnings growth this year, which is roughly in line with estimates.
Despite those challenges, Accenture stock has risen about 27% since the beginning of the year, easily outperforming the S&P 500's nearly flat growth. However, the stock isn't cheap at 21 times earnings, compared to the average P/E of 19 for the IT services industry.
Cognizant Technology Solutions
New Jersey-based Cognizant is often compared to Indian IT services companies Wipro (NYSE:IT) and Infosys (NYSE:INFY) since over two-thirds of its employees are based in India. Like Accenture, Cognizant provides consulting and IT services to a wide range of companies.
Yet Cognizant is growing at a much faster rate than Accenture. Last quarter, Cognizant's revenue rose 22.6% annually to $3.09 billion and beat estimates by $60 million. Financial services revenue, which accounted for over 40% of its top line, improved 18%. Healthcare revenue, which accounted for 29% of sales, rose 39%, thanks to its acquisition of healthcare software company TriZetto last year. The company's other sectors posted double-digit growth along with positive growth across all geographic regions. Currency headwinds only increased expenses by $10.4 million.
For the third quarter, Cognizant expects to generate revenues of at least $3.14 billion, which tops the consensus estimate of $3.13 billion. For the full year, Cognizant expects to generate at least $12.3 billion in revenues, which would equal 20% sales growth compared to 2014. Earnings per share are also expected to improve at least 15%, which would beat analyst expectations.
That rosy guidance also lifted shares of Wipro and Infosys, but Cognizant has outperformed both stocks over the past 12 months with a whopping 47% gain. However, that big rally makes Cognizant stock a bit pricey at 26 times earnings, especially in comparison to Wipro's and Infosys' respective P/E ratios of 23 and 22.
The key takeaways
Many tech investors overlook IT services stocks for companies with hotter products or higher growth potential. That would be a mistake, since both Accenture and Cognizant are streamlined "pure plays" on IT services which aren't weighed down as much extra baggage as bigger players like IBM. Both stocks have been resilient in the volatile market despite their pricier valuations, which means that they might hold up well during market downturns.