India Wages, New Jersey Profits

01/11/2011 12:56 pm EST

Focus: GLOBAL

Nicholas Vardy

Editor, Bull Market Alert, The Alpha Investor Letter, and The Global Guru

Outsourcing tech giant Cognizant is growing fast without sacrificing profit margins, writes Nicholas Vardy in Global Bull Market Alert.

Indian outsourcing was all over the headlines a few years back. Then came the Great Recession, and the entire sector seemed to collapse—along with the shares of the Indian companies that were the global outsourcing leaders.

But that turned out to be a mere blip in the relentless progress of global outsourcing companies. In 2000, the Indian software and outsourcing business stood at a mere $5.7 billion. Today, that sector has grown by more than tenfold, coming in at just over $60 billion a year. And a study just released by Gartner has confirmed that India remains the world's favorite destination for offshore outsourcing.

New Jersey-based Indian outsourcing play Cognizant Technology Group (Nasdaq: CTSH), is a bet that after a strong 2010, this sector will continue to yield big profits for investors. Here's why I think Cognizant, a US-based company with more than 75% of its 100,000-plus employees based in India, is set to continue performing well as the global economic recovery gains momentum.

Cognizant does more than just staff low-end call centers, or process online catalog orders. Its workers test drugs, develop software, and engage in a host of other sophisticated activities. As global growth picks up, companies need to allocate more work to more people. At the same time, these same companies are reluctant to hire new employees. Cognizant offers the perfect solution.

Margins Made Abroad
So what's Cognizant's secret? High operating margins that consistently exceed 20%, thanks to low-cost software development centers and employees who are located in India—with a dash of Argentina, China, and Hungary thrown in for good measure. Although they are rising, Indian salaries still are a fraction of the starting-level base pay for a US programmer.

Cognizant’s strong position is reflected in its consistently excellent performance. Sales grew a whopping 43% last quarter, and earnings per share jumped 44%. Analysts expect earnings per share to hit $2.67 for 2011. Based on Cognizant's consistent outperformance of expectations, I think this number might end up closer to $2.90. We'll get a hint of what's to come when the company announces fourth-quarter earnings on Feb. 7.

Cognizant recently authorized a share repurchase program of up to $150 million over the next 12 months. That indicates management's confidence.

If you buy Cognizant, place your initial stop at $64.50. If you want to play the options, I recommend the April $80 calls, which last traded at $2.45. [Cognizant shares closed at $75.33 Monday. Another Asian tech play recommended by Vardy last month finished the day at an all-time high after a 13% gain in the last month—Editor.]

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