Demand for information technology services is growing much faster than the 2.5% rate of the U.S. economy. But is there an opportunity to invest in leading providers — such as Cognizant Technology Solutions (NASDAQ:CTSH) or Accenture (NASDAQ:ACN)?
On Wednesday morning, Cognizant — it cleverly splits its people between business process specialists in the U.S. and other countries near clients and programmers in India — reported great results. In the third quarter, Cognizant reported adjusted EPS of 80 cents per share, beating forecasts by nine cents, and a 31.6% revenue rise to $1.6 billion, which was $20 million ahead of expectations, according to Thomson Reuters I/B/E/S.
After more than two years of exceeding investor expectations, Cognizant CEO Francisco D’Souza said in a statement, “In spite of persistent macro-economic uncertainties, clients throughout the world continue to invest.” What’s interesting here is that client discretionary development funds are flowing more to Cognizant than its Indian rivals, which lack CTSH’s ability to translate customer business requirements into software.
Meanwhile, Cognizant competitor Accenture beat expectations when it reported results Sept. 27. Its reported EPS of 91 cents was two cents above the Thomson Reuters consensus estimate of 89 cents, and its revenue was up 23.4% to $6.69 in its fiscal fourth quarter.
Moreover, Accenture boosted its guidance to analysts. For fiscal 2012, Accenture forecast revenue growth between 7% and 10% and earnings between $3.80 and $3.88 — that’s between 41 and 81 cents higher than the Zacks Consensus Estimate of $3.39.
But that great forecast was not enough to keep analysts from being negative on ACN stock. Barclays downgraded Accenture from “overweight” to “equal weight” on Nov. 1.
So which is the best stock to buy? Should you avoid Accenture and buy Cognizant? No. Avoid both. Why?
- Cognizant: Strong growth, healthy margins; expensive stock. CTSH’s sales have increased 40.1% in the past 12 months to $5.4 billion, while net income climbed 37.1% to $826 million — yielding a 15.4% net profit margin. Its price/earnings-to-growth ratio of 1.27 (where a PEG of 1.0 is considered fairly valued) is expensive on a P/E of 26.66 and expected earnings growth of 21% to $3.38 in 2012.
- Accenture: Decent growth, fair margins; expensive stock. ACN’s sales have increased 18.4% in the past 12 months to $27.4 billion, while net income grew 27.9% to $2.28 billion — yielding a 9.3% net profit margin. Its PEG of 1.50 is expensive on a P/E of 16.9 and expected earnings growth of 11.3% to $4.27 in fiscal 2013.
Both stocks are overvalued, but if you can pick up CTSH on a market down-draft, it looks like the stronger bet. Because of its high PEG, Cognizant will have to grow earnings faster than investors’ high expectations to generate the positive surprise needed to lift its stock.
As of this writing, Peter Cohan did not own a position in any of the aforementioned stocks.