Why Wedgewood Loves Cognizant Technology Solutions (CTSH)

St. Louis, Missouri investment firm Wedgewood Partners recently published its Q2 investor letter – you can download a copy here. The letter included the firm’s thoughts on Cognizant Technology Solutions Corp (NASDAQ: CTSH) and other companies. In this article, we’re going to take a look at Wedgewood’s comments about Cognizant.

Wedgewood writes in the letter:

Cognizant detracted from absolute as well as relative performance in the quarter. After being a strong performer during both the second half of 2017 and the first quarter this year, Cognizant gave some of that relative performance back after reporting earnings that disappointed analysts. While the report was in line with consensus expectations, management did reduce full year 2018 earnings per share (EPS) estimates to reflect a higher tax rate following the U.S. Tax Cuts and Jobs Act enacted last year. Essentially, management now has better clarity around calculation of certain income earned for American taxpayers involved in foreign businesses which ultimately provides a limit on the amount of foreign tax credits the Company receives. While this was not clear when management gave original guidance in February, the Company now has a better understanding of the impact, resulting in the reduced EPS guidance. We are not concerned with the release because the change reflects the updated tax-rate expectations, rather than an issue with Company execution or a decline in industry or market expectations. Consensus, however, has become used to “beat and raise” quarters and thus shares sold off on the report.

Another reason we remain convicted is that the Company’s margin expansion story remains on track. Management reaffirmed 2018 operating margin guidance of approximately 21% and they stand behind reaching 22% by the end of 2019. Helping achieve this is Cognizant’s continued execution of their cost-cutting initiatives throughout the year, and as digital revenue continues to grow in the mid-to-high 20% range. As a reminder, digital revenue made up 29% of total company revenue during the quarter. This higher margin business is growing faster than Company average. The healthcare segment remains strong and the financial services segment continues to improve. Management even noted that, with the changes in tax reform and rising interest rates, they are starting to see more spending in the large money center banks, which has been an area of sluggish growth the last several quarters.

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New Jersey-based Cognizant Technology Solutions Corp (NASDAQ:CTSH) is an information technology, technology, consulting, and business process services firm. The company’s stock has been performing well so far this year. Since the beginning of the year, the stock has gained 16.60%. During the last 12 months, the share price has surged more than 20%. For the first quarter of 2018, the company reported revenues of $3.91 billion, up 10.3% from $3.55 billion in the same quarter last year. It had net income of $520 million, or $0.88 per share, down from $557 million, or $0.92 per share, in the prior year’s same quarter.

Meanwhile, CTSH is also a favorite stock of many notable hedge funds tracked by Insider Monkey including Fisher Asset Management, Dalton Investments, and Southpoint Capital Advisors. As of the end of the fourth quarter of 2017, there were 55 funds in our database that hold bullish positions in the company.