Investors Are Undervaluing Cognizant Technology Solutions Corporation (NASDAQ:CTSH) By 20.82%
How far off is Cognizant Technology Solutions Corporation (NASDAQ:CTSH) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. This is done using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in October 2018 so be sure check out the updated calculation by following the link below.
Check out our latest analysis for Cognizant Technology Solutions
What’s the value?
I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF ($, Millions) | $2.62k | $2.95k | $3.32k | $3.74k | $4.21k |
Source | Analyst x9 | Analyst x6 | Est @ 12.65% | Est @ 12.65% | Est @ 12.65% |
Present Value Discounted @ 9.87% | $2.38k | $2.44k | $2.50k | $2.57k | $2.63k |
Present Value of 5-year Cash Flow (PVCF)= US$12.5b
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 9.9%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$4.2b × (1 + 2.9%) ÷ (9.9% – 2.9%) = US$62.7b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$62.7b ÷ ( 1 + 9.9%)5 = US$39.2b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$51.7b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $89.08. Relative to the current share price of $70.53, the stock is about right, perhaps slightly undervalued at a 21% discount to what it is available for right now.
The assumptions
I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Cognizant Technology Solutions as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 9.9%, which is based on a levered beta of 0.982. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For CTSH, I’ve compiled three important factors you should look at:
Financial Health: Does CTSH have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does CTSH’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of CTSH? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the NASDAQ every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
