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The Chairman of the Board Bought Shares of Cognizant Technology Solutions Corp (CTSH)

A Form 4 filed with the SEC has disclosed that John Klein, who is the Chairman of Cognizant Technology Solutions Corp (NASDAQ:CTSH)’s Board of Directors, directly purchased 7,500 shares of stock on June 14th 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 trading) and so we like to take at least a brief look at significant insider purchases.

Cognizant Technology Solutions Corp (NASDAQ:CTSH)

Cognizant Technology Solutions Corp (NASDAQ:CTSH) 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 by 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 93 cents compared to 79 cents in last year’s Q1. Cognizant Technology Solutions Corp (NASDAQ:CTSH) 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 0.9.

In addition to insider trading 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 Technology Solutions Corp (NASDAQ:CTSH) at the end of March (find Mandel’s favorite stocks).

The two closest peers for Cognizant Technology Solutions Corp (NASDAQ:CTSH) are Infosys Ltd ADR (NYSE:INFY) and Wipro Limited (ADR) (NYSE:WIT). 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 Technology Solutions Corp (NASDAQ:CTSH).

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 there. The opposite is the case at Wipro: net income has come 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 Corporation (NASDAQ:ORCL) and International Business Machines Corp. (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 that 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.

Disclosure: I own no shares of any stocks mentioned in this article.

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