Cognizant: Model for Indian IT - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Cognizant: Model for Indian IT

Jun 3, 2004

Almost exactly a year back (in June 2003), we did a write-up comparing Infosys with Cognizant Technologies, a US software company (managed by Indians) listed in the US markets. A year forward, let us see how the latter, i.e., Cognizant, has shaped up vis-a-vis the Indian software behemoth.


Note: Returns are calculated on Rs 100 invested in June 2001

As seen from the graph above, Cognizant's stock has returned almost 209% more than Infosys over the past three years. Even when we consider the year gone by, returns for Cognizant are higher than Infosys' by around 17%. We believe that since the software services industry is global in nature, such a major difference in the returns generated by these two companies is more likely a result of their relative performance and what investors perceive their future growth to be.

The graphs above, especially the one on the right, clearly indicates the reason why investors have been more optimistic for Cognizant's growth than Infosys'. From the stratospheric growth rates (100% plus) witnessed during the tech boom, Infosys' earnings growth has slid to around 30% in FY04. On the other hand, Cognizant's earnings growth, also after dropping from its previous highs, has clawed back to higher levels (56% and 66% in FY03 and FY04 respectively) during the past two years.

One important reason for Cognizant's higher profit growth over the past few years is that the company has consistently maintained its margins when its revenues have shown higher growth. At 19.6%, Cognizant's operating margins, although lower than Infosys' margins (32.9%) have been stable because the company has not seen as much pressure on its billing rates as Infosys. This is because the former, being a relatively younger company, has projects that have billing rates that are already low and in line with present average billing rates. Infosys, on the other hand, has seen its older clients negotiating hard to rationalise billing rates further.

As we had said earlier, there is one more reason why Cognizant has the capability of a higher profitability growth than Infosys. This is due to the former's low incremental marketing and administrative costs. Cognizant has been spending around 20%-24% of its revenues towards selling, marketing and administrative expenses in the past. While this may seem large when compared to Infosys' spending on these heads at 14.3% of revenues, the incremental spending for Cognizant is much lower than the latter. This is because Cognizant already has systems in place to service its clients that are highly concentrated in the US geography.

At their respective market prices, while Cognizant trades at a P/E multiple of 48x FY04 earnings, Infosys' P/E on its FY04 earnings are around 40x (on the NASDAQ). Infosys' P/E in the Indian markets is 29x FY04 earnings and 20x FY06 our expected earnings.

Cognizant can very well be a case study for Indian software majors like Infosys. The company follows the same business model of providing services through coordination between onsite and offshore efforts. Cognizant's development centres are all based in India (except one in Ireland) while its top management and sales teams reside in the US. Now, as Indian companies like Infosys and Wipro grow larger in size and penetrate deeper into the foreign markets (including the US), they, more or less, have to follow the same model. While they fulfill the first criterion, i.e., development centres based in India and other low-cost destinations, they still need to move forward in establishing deeper contacts with their clients. And this becomes easy when the management is in close proximity to its clients.

While following the model of Cognizant, going forward, Indian software majors are likely to have similar operational parameters as the former. More simply, while the average billing rates they charge are likely to settle down at a lower global average, their operating margins are also likely to follow a similar path and settle at levels between 20%-25%. This will be owing to higher incremental costs that these Indian companies have to bear at least for the next few years, or till they do not establish themselves very close to their clients.

Now, what lessons can investors learn from this?

  1. They need not worry about falling margins of companies like Infosys who are aggressively penetrating deeper into the foreign markets, something they are doing through large incremental spending on the sales and marketing fronts. As we have mentioned above, this may result into Infosys' margins settling down at lower levels (between 20%-25%). However, an established base will then require low incremental spending and provide the company with a strong base to move towards higher levels of growth.

  2. We believe that while Infosys' margins shall settle down at lower levels, they will still be higher than Cognizant, mainly due to the difference in service mix between the two companies. This is because of the fact that while Infosys has been more aggressive in moving up the value chain, almost the whole of Cognizant's revenues continues to be dominated by services like application development and maintenance.

Equitymaster requests your view! Post a comment on "Cognizant: Model for Indian IT". Click here!

  

More Views on News

MINDTREE at All Time High; BSE IT Index Up 0.4% (Market Updates)

Jun 17, 2021 | Updated on Jun 17, 2021

MINDTREE share price has hit an all time high at Rs 2,508 (up 0.5%). The BSE IT Index is up by 0.4%. Among the top gainers in the BSE IT Index today are MINDTREE (up 0.5%) and COFORGE (up 0.4%). The top losers include HEXAWARE TECHNOLOGIES and FIRSTSOURCE SOLUTIONS (down 0.1%).

MPHASIS at All Time High; BSE IT Index Down 0.1% (Market Updates)

Jun 17, 2021 | Updated on Jun 17, 2021

MPHASIS share price has hit an all time high at Rs 2,132 (up 0.7%). The BSE IT Index is down by 0.1%. Among the top gainers in the BSE IT Index today are MPHASIS (up 0.7%) and PERSISTENT SYSTEMS (up 1.2%). The top losers include HEXAWARE TECHNOLOGIES and INFOSYS .

Birlasoft Hits 52-week High as Company Signs AI Partnership (Views On News)

Jun 9, 2021

The stock has rallied 350% in the last year. Is there more steam left?

What's Behind the Rally in Wipro Shares? (Views On News)

May 31, 2021

Wipro shares outperforms TCS and Infosys over the past year. Is the rally justified?

Happiest Minds Q4 Results: Profit Grows Over Six-Fold; Company Eyes 20% Organic Growth in FY22 (Views On News)

May 14, 2021

Key takeaways from Happiest Minds Technologies Q4FY21 results.

More Views on News

Most Popular

Hotel Stocks Will Reward Investors (Fast Profits Daily)

Jun 8, 2021

This is why I'm bullish on the hotel and hospitality sector.

My 'Unlock' Investments (Fast Profits Daily)

Jun 11, 2021

The best unlock investments you can make in the market.

The Most Visible Sign of India's Revival is on Two Wheels (Profit Hunter)

Jun 9, 2021

Investing in the best stocks could result in wealth compounding on a massive scale.

How I Discovered a 400-Year-Old Open Secret to Extreme Wealth (Profit Hunter)

Jun 11, 2021

Charlie Munger's open secret about investing success.

More

India's #1 Trader
Reveals His Secrets

Secret To Increasing Your Trading Profits Today
Get this Special Report,
The Secret to Increasing Your Trading Profits Today, Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE IT


Jun 17, 2021 11:07 AM

S&P BSE IT 5-YR ANALYSIS

COMPARE COMPANY

MARKET STATS