The Chairman of the Board Is Bullish About This Tech Stock

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A Form 4 filed with the SEC has disclosed that John Klein, who is the Chairman of Cognizant Technology Solutions' (NASDAQ: CTSH) Board of Directors, directly purchased 7,500 shares of stock on June 14 at an average price of $62.78 per share. This gives him a total of over 250,000 shares held directly and more being held in a related trust.

Economic theory suggests that insiders should generally prefer diversifying their wealth to buying additional shares and increasing their company-specific risks, and so, insider purchases should indicate more confidence than usual in the stock’s prospects. Studies do in fact show a small outperformance effect for stocks bought by insiders (read our analysis of studies on insider transactions) and so, we like to take at least a brief look at significant insider purchases.

Cognizant is a $19 billion market cap company whose businesses include consulting and IT services, outsourcing services, and information management services. The company’s revenue grew 18% last quarter compared to the first quarter of 2012, and with margins holding steady, net income was up 17%. With share count falling, earnings per share rose to $0.93 compared to $0.79 in last year’s Q1.

Cognizant is currently valued at 18 times trailing earnings, and at a P/E multiple of 17 if we annualize the numbers from the most recent quarter. That’s not too high a valuation, and given how well the business has been doing recently, we certainly could consider it a potential “growth at a reasonable price” stock. Wall Street analyst expectations for the next several years imply a five-year PEG ratio of 0.90.

In addition to insider activity, we also track quarterly 13F filings from hundreds of hedge funds. We use the information in these filings to help us develop investment strategies (for example, we’ve found that the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year) and also to track interest in individual stocks over time. We can see from our database that billionaire Stephen Mandel’s Lone Pine Capital owned 8.7 million shares of Cognizant at the end of March (find Mandel's favorite stocks).

The two closest peers for Cognizant are Infosys (NYSE: INFY) and Wipro. These companies’ stocks are priced at small discounts to Cognizant, with trailing earnings multiples in the 14-15 range. Interestingly, the sell-side is forecasting little to no growth on a forward basis at each of these companies in contrast to the high expectations at Cognizant.

Infosys experienced a 9% increase in sales in its most recent quarter compared to the same period in the previous fiscal year, but earnings were actually down and so, we’d say conservative expectations are warranted here. The opposite is the case at Wipro: net income came in higher, but with revenue slipping, we’d expect that future earnings growth may not be sustainable. Each of these stocks is down in the last year against a rising market.

We can also compare Cognizant to Oracle (NYSE: ORCL) and International Business Machines (NYSE: IBM), which are certainly larger companies but are also major players in enterprise software and services. Oracle’s recent financial performance has been essentially flat on both top and bottom lines. Analysts are still expecting significant increases in earnings per share, as shown by the fact that the stock’s trailing and forward P/E multiples are 16 and 12, respectively. While to some degree the company could increase EPS through buybacks, we’d still avoid it for now.

The first quarter of 2013 saw both IBM’s revenue and earnings falling off slightly versus a year earlier. With the company roughly matching Infosys and Wipro in terms of being valued at 14 times trailing earnings, it doesn’t seem like a good buy at this time either -- we’d want to be able to anticipate growth in net income at that pricing.

As a result, Cognizant actually comes out looking more interesting than any of the four stocks in its peer group we’ve discussed, based purely on quantitative measurements of valuation and recent performance, and the insider purchase is a positive sign as well. We’d be interested in doing more research on the company, particularly in terms of how it has outperformed these other companies and how sustainable its advantages are.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article.The Motley Fool owns shares of International Business Machines. and Oracle.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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