A Nice Problem To Have (CTSH)
Cognizant Technology Solutions (CTSH) is a stock we have followed for a number of years. Although it trades at a relatively lofty 47x 2006 earnings expectations, its year over year growth in revenue (57.1 per cent), net income (47.5 per cent) and EPS (45.4 per cent) seem to argue that the valuation is merited. Especially when one considers that the reported growth in net income and earnings per share was hindered by the new requirement to record an expense for stock options. Those multiples appear reasonable if that growth is at all sustainable. Is it?
We have always been in awe of Cognizant’s growth, especially in its business of IT consulting. (Cognizant uses an onsite/offshore model in which local consultants work on premises at customer facilities to determine need and coordinate a team of engineers in India to do the needed work.) Since there are only so many billable hours in the day, in order to increase revenue consulting firms need to increase the number of consultants. And between March 31, 2005 and March 31, 2006 Cognizant added 9,700 employees to end the latest quarter with a total of 26,750.
Think about it. A company that already had a large number of employees (17,050 at March 31, 2005) grew its employee base by 57 per cent in one year. Plus, if the 11 per cent annualized turnover the company experienced in the latest quarter is typical (by our recollection it seems on the low side) that means they would have lost 2,400 employees to attrition during the time (11 per cent of the average number of employees during the year.)
So to add 9,700 employees the company had to hire 12,000. Almost 50 new hires every working day. Even if they hire a quarter of all applicants that means interviewing 200 per day. And if they want to grow another 50 per cent next year they will have to hire 75 new employees each workday this year. By all accounts there are plenty of graduating software engineers in India to hire. But that is still one heck of a logistical exercise. And someday it will be too much to handle and the company will trip up.
If we had to point to one specific risk factor as being Cognizant’s greatest, it would be managing all of that growth. We don’t think it will happen this year, but it could. Or, just as likely, they could continue to coast for several more years. And in the meantime, it is a nice problem to have.
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[...] We were impressed a few months ago when we noted that outsourcing firm Cognizant (CTSH) had hired 12,000 new employees in a single year. (After attrition, the net increase in employees was just under 10,000.) So imagine how impressed we were to learn that Infosys (INFY) hired 10,795 people during the second quarter (July-September) of the current fiscal (FY 2006-07). As competitive as the job market in India is, it is still hard to hold on to good employees. Infosys notes: With attrition level increasing to 12.9 per cent in the last 12 months, the net addition was 7,741 by the end of September, as against 6,390 a year ago and 5,694 by the end of previous quarter (April-June) when the attrition levels were 10 per cent and 11.9 per cent respectively. [...]
[...] Outsourcing Staff Shortage? We have long been impressed with the ability of Indian outsourcing firms to hire enough new employees to sustain their tremendous growth rates. As we noted in May, 2006: Think about it. A company that already had a large number of employees (17,050 at March 31, 2005) grew its employee base by 57 per cent in one year. Plus, if the 11 per cent annualized turnover the company experienced in the latest quarter is typical (by our recollection it seems on the low side) that means they would have lost 2,400 employees to attrition during the time (11 per cent of the average number of employees during the year.) [...]
[...] It’s been a while since we first started warning that the biggest problem for Indian IT outsourcing operations would be continuing to find enough employees to sustain their impressive growth rates. Now, however, it seems like it truly is becoming a problem. In the latest example, IBM sees growth in India but skill shortage a worry (Reuters.com): But the rush for staff has led to rising wages and a skills shortage.”It’s (skill shortage) a challenge and we have got to address that … currently all of us are recruiting,” Annaswamy said. [...]
[...] Cognizant (CTSH) – one of these days the growth will hit a wall, but probably not this day [...]