Earnings

Choosing Between Cognizant Technology Solutions Corporation (CTSH) and Automatic Data Processing, Inc. (ADP)

 

Cognizant Technology Solutions Corporation (NASDAQ:CTSH) shares are up more than 27.41% this year and recently increased 0.27% or $0.19 to settle at $71.39. Automatic Data Processing, Inc. (NASDAQ:ADP), on the other hand, is up 14.14% year to date as of 12/27/2017. It currently trades at $117.31 and has returned -0.47% during the past week.

Cognizant Technology Solutions Corporation (NASDAQ:CTSH) and Automatic Data Processing, Inc. (NASDAQ:ADP) are the two most active stocks in the Business Software & Services industry based on today’s trading volumes. Investors are clearly interested in the two names, but is one a better choice than the other? We will compare the two companies across growth, profitability, risk, valuation, and insider trends to answer this question.

Growth

One of the key things investors look for in a company is the ability to grow earnings at a high compound rate over time. Analysts expect CTSH to grow earnings at a 13.93% annual rate over the next 5 years. Comparatively, ADP is expected to grow at a 10.77% annual rate. All else equal, CTSH’s higher growth rate would imply a greater potential for capital appreciation.



Profitability and Returns

Growth isn’t very attractive to investors if companies are sacrificing profitability and shareholder returns to achieve that growth. We will use EBITDA margin and Return on Investment (ROI), which control for differences in capital structure between the two companies, to measure profitability and return., compared to an EBITDA margin of 23.01% for Automatic Data Processing, Inc. (ADP). CTSH’s ROI is 12.80% while ADP has a ROI of 29.00%. The interpretation is that ADP’s business generates a higher return on investment than CTSH’s.

Cash Flow 




The amount of free cash flow available to investors is ultimately what determines the value of a stock. CTSH’s free cash flow (“FCF”) per share for the trailing twelve months was +1.02. Comparatively, ADP’s free cash flow per share was -0.18. On a percent-of-sales basis, CTSH’s free cash flow was 4.46% while ADP converted -0.64% of its revenues into cash flow. This means that, for a given level of sales, CTSH is able to generate more free cash flow for investors.

Liquidity and Financial Risk

Liquidity and leverage ratios are important because they reveal the financial health of a company. CTSH has a current ratio of 3.30 compared to 1.10 for ADP. This means that CTSH can more easily cover its most immediate liabilities over the next twelve months. CTSH’s debt-to-equity ratio is 0.07 versus a D/E of 0.51 for ADP. ADP is therefore the more solvent of the two companies, and has lower financial risk.

Valuation

CTSH trades at a forward P/E of 16.43, a P/B of 3.84, and a P/S of 2.94, compared to a forward P/E of 27.08, a P/B of 13.12, and a P/S of 4.17 for ADP. CTSH is the cheaper of the two stocks on an earnings, book value and sales basis. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.

Analyst Price Targets and Opinions

A cheap stock isn’t a good investment if the stock is priced accurately. To get a sense of “value” we must compare the current price to some measure of intrinsic value such as a price target. CTSH is currently priced at a -12.51% to its one-year price target of 81.60. Comparatively, ADP is 2.23% relative to its price target of 114.75. This suggests that CTSH is the better investment over the next year.

The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.00 for CTSH and 2.60 for ADP, which implies that analysts are more bullish on the outlook for ADP.

Risk and Volatility

To gauge the market risk of a particular stock, investors use beta. Stocks with a beta above 1 are more volatile than the market as a whole. Conversely, a beta below 1 implies below average systematic risk. CTSH has a beta of 1.07 and ADP’s beta is 0.87. ADP’s shares are therefore the less volatile of the two stocks.

Insider Activity and Investor Sentiment

Comparing the number of shares sold short to the float is a method analysts often use to get a reading on investor sentiment. CTSH has a short ratio of 2.82 compared to a short interest of 3.01 for ADP. This implies that the market is currently less bearish on the outlook for CTSH.

Summary

Cognizant Technology Solutions Corporation (NASDAQ:CTSH) beats Automatic Data Processing, Inc. (NASDAQ:ADP) on a total of 11 of the 14 factors compared between the two stocks. CTSH is growing fastly, has higher cash flow per share, has a higher cash conversion rate, higher liquidity and has lower financial risk. In terms of valuation, CTSH is the cheaper of the two stocks on an earnings, book value and sales basis, CTSH is more undervalued relative to its price target. Finally, CTSH has better sentiment signals based on short interest.

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