Conventional wisdom holds that magazine cover stories are contrarian indicators - by the time a company’s success or failure reaches the cover page of a major publication the story is so well known as to be completely reflected in the stock price. Therefore, all good news is priced in and the stock can only underperform or all bad news is priced in and the stock can only outperform.

While simplistic, the magazine cover indicator now has the support of recent academic research. This research did find that cover story headlines on Business Week, Fortune and Forbes tended to indicate that the mood (bullish or bearish) of the story was about to change in the market.

As a result of this research, we have decided to develop a portfolio of stocks based on using those three magazine’s covers as a contrary indicator. We also track this portfolio on StockPickr. This week’s results:

International Business News : Business News, Technology Industry News

The Real Cost Of Offshoring
U.S. data show that moving jobs overseas hasn’t hurt the economy. Here’s why those stats are wrong

Contrary Pick: Hmm. Is this headline negative about offshoring or the US economy? I’m going with offshoring and saying the contrary pick is to buy the offshore firms like Cognizant (CTSH), Infosys (INFY) and Wipro (WIT).
Forbes and Fortune, being bi-weeklies, were not updated this week.

Infosys Technologies (INFY) Announced Results for the Quarter and Year Ended March 31, 2007, and what struck us was not sales or earnings, but employees:

• Gross addition of 5,992 employees (net 2,809) for the quarter by Infosys and its subsidiaries
• 72,241 employees as on March 31, 2007 for Infosys and its subsidiaries

In our earnings preview we said “They will make the numbers, but investors will listen closely to the update on visas and employee retention.” Doing the math, 3,182 employees left the company (the difference between net and gross.) That number is 5.2% of the number of employees at the beginning of the quarter, which we figure to be an annualized attrition rate along the lines of 20%, in line with the rates that have concerned us for some time. However, instead of the more than 10,000 new hires in the July-September quarter last year (which admittedly may have been boosted by graduation timing) there were less than 6,000 this quarter. As a result, the total number of employees grew just 4% sequentially - perhaps a 16% annualized rate.

While still impressive, it is important to remember that IT outsourcing is a labor-intensive industry. Revenue growth is very much reliant on adding employees and making them more productive. While revenues can grow faster than employees in the short term due to improved productivity, in the long term the relationship will be fairly tight.

Infosys grew earnings per share by 64% last year and is forecasting 27% growth this year. If the current run rate of employee growth is any indication, investors should expect a significant slowdown next year as well.

Given how difficult it has been for us to find an available web designer lately (let alone one we can afford) we weren’t especially surprised to see this nugget:

H-1B cap for fiscal 2008 reached in two days - 4/4/2007 - Electronic News

Only one day after starting the receipt of applications, U.S. Citizenship and Immigration Services (USCIS) announced Tuesday that it had already received enough H-1B petitions to meet the congressionally mandated cap for fiscal year 2008. Contrastingly, it took nearly two months for the cap to be reached for fiscal year 2007.

According to the U.S. Department of State, H-1B classification applies to persons in a specialty occupation which requires the theoretical and practical application of a body of highly specialized knowledge requiring completion of a specific course of higher education. This classification requires a labor attestation issued by the Secretary of Labor (65,000). This classification also applies to Government-to-Government research and development, or co-production projects administered by the Department of Defense (100). The H-1B visa is widely used among the IT outsourcing firms such as Cognizant (CTSH), Infosys (INFY) and others, who need feet on the ground on site to determine needs and communicate them to the coders back in India.

Whether the on-site team is itself Indian is of relatively little importance. The cost efficiencies still dictate that a good deal of work will be done offshore. Meanwhile, on-site staff are paid local rates, so they can be locals just as easily as not. And with the visa cap being met virtually the moment the doors opened, it is a safe bet that more of them will be locals this year. Which helps explain our difficulties finding someone to help us with our site.

The news may have a short-term impact on the outsourcing firms. The last time there were visa cap issues investors reacted harshly for a couple of months on the belief that the shortage of immigrant workers would affect the rapid growth in offshore outsourcing. It did not, of course, but it is unclear whether investors were completely disabused of the idea. This time is also somewhat different because the firms are also having difficulty finding (or at least keeping) workers in India as well.

The stocks have had a strong recent run and may be looking for any excuse to pull back. This visa cap offers one such excuse.

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.

“We know how to recruit quality personnel which are available in India, but we also know how to train them, how to give them career options and how to make them feel proud of being an IBM-er.”

The pain is being shared fairly evenly across all those who want a big presence in India. But that doesn’t make it any less difficult to hire and retain quality staff.

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.)

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.

Since then, the stocks have continued to soar.

Unfortunately, the “one specific risk factor” has also grown in importance. Infosys turnover rose to 12.9% in the third quarter, and Cognizant said it was something management was monitoring. Now, based on Infosys’ fourth quarter report, “monitoring” may translate into “watching it get worse.”
Infosys faces quality problems in staff : HindustanTimes.com

Can there be problems when a company is surging a wave of plenty with $1 billion in cash? Apparently, yes.Infosys Technologies may be rich and hiring by the thousands, but has to compete with giants like IBM and Accenture in wooing engineers and programmers, and staff attrition is a looming problem.

The company’s attrition rate rose to 13.5 per cent in the latest October-December quarter compared with 10 per cent during the same period last year. But not all of them left on their own.

About 1.3 percentage points of the 13.5 per cent attrition are attributed to poor quality of work by trainees who could not match up to expectations.

Despite the recent rally, P/E multiples have remained near their recent averages (the stock price rise has been backed by fundamentals.) However, at the current rates of attrition the recent growth rates will soon prove unsustainable.

We have noted several times how impressed we are with the rapid hiring pace at Indian IT services firms such as Infosys (INFY), Cognizant (CTSH) and Wipro (WIT). In fact, we viewed the need to constantly hire more people one of the only obstacles in the path of their rapid growth.

Still, as cost effective as labor based in India may be, the firms need feet on the ground in its customer’s local countries to take the orders and coordinate efforts. So perhaps it is not surprising that the offshore firms are now preparing a large onshore hiring thrust. The Telegraph - Calcutta : Business:

Wipro plans to have more foreign employees as it expands its business in Europe and South America.The company expects foreign employees to make up 25 per cent of its total workforce in future against 5 per cent at present.

Wipro chief Azim Premji today said as part of its policy to go global, the company would have to employ more local nationals in the countries to which it was spreading its wings.

Let’s hope they get started soon. The employment numbers could use their kind of hiring spree.

Cognizant’s (CTSH) earnings beat the consensus target as usual, but the stock reaction was fairly muted. In part this is likely due to the fact that strong earnings reports out of Indian outsourcing peers Infosys (INFY) and Wipro (WIT) had already clued investors to expect a strong outcome. However, it also points to signs that the supply of cheap coders in the subcontinent may be reaching some limitations. According to the Earnings Call Transcript from SeekingAlpha [emphases our own]:

In building the foundation for future growth, we aggressively invested in building our employee base, increasing our headcount by over 15% sequentially and adding about 4,700 employees around the world. We were very pleased with our ability to attract the best talent in the industry, a testament to Cognizant’s reputation as an employer of choice in our industry. During Q3, we saw a reversal of the positive attrition trends from earlier this year. For the first six months of 2006, our annualized attrition of 13.2% was running about two percentage points below our annualized attrition of 15.3% for the first half of 2005. Yet attrition in Q3 increased to about 20%, four percentage points higher than in Q3 2005.It is important to note that our YTD annualized attrition is approximately 15.5%, roughly equal to our attrition rate for the same period during 2005 and that attrition is an issue that our entire industry is facing. Historically we have experienced an increase in attrition in Q3, as those employees returning to graduate school leave the company. However, the recent increase was certainly higher than we expected or desired. Based on our extensive exit interview process, higher education ranks highly but no single factor accounts for the recent increase….

Fundamentally, we are committed to returning attrition to its normalized levels and ensuring that our employees have world class opportunities to develop their talents and careers within Cognizant.

Our October numbers show lower attrition rates than Q3 and we will continue to closely monitor the trend.

When we first profiled Cognizant in May, we highlighted employee growth as their most significant issue:

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.

Judging from management’s comments, it is getting a little less nice. But one analyst was quick to put it in context:

Q - Adam Frisch – UBS

Quick housekeeping, Gordon the 60% revenue growth, was that YoverY or sequential?

A - Gordon Coburn

Hang on… that was…

Q - Adam Frisch – UBS

I’m just kidding, I’m trying to make a point. On attrition, obviously that’s the one negative data point, but it’s just in one quarter.

Indeed. It isn’t quite run for the exits time, but the attrition rate is enough to suggest that investors should join management and “closely monitor the trend.”

Indian software firms remain on a tear. Wipro (WIT) reported 48% profit growth on 41% sales growth.  The company hired 5,328 new employees in the last three months alone, bringing its total to more than 61,000. We would have been impressed if it’s similarly-sized peer Infosys (INFY) hadn’t hired nearly twice as many.

DELL (DELL) continues to lose ground to Hewlett Packard (HPQ - Annual Report). Gartner Inc. said Hewlett-Packard moved into the No. 1 position for the first time since the fourth quarter of 2003 with a lead of 110,000 units over Dell, while IDC put the lead at 28,000 units, which it considered a statistical tie at 17.2 percent of the world market. Still, Apple (AAPL) is doing even better.
Price wars don’t help anybody. At least not Intel (INTC - Annual Report) or AMD (AMD - Annual Report).

Keane (KEA) isn’t getting IT done any better than IBM (IBM - Annual Report) or CDW (CDWC). From the conference call: “On a year-to-date basis, Keane’s revenues are up 4%, excluding the IBM staffing business, which we divested last year.” That is more or less in line with the industry, which shouldn’t get many investors excited.