Top Picks 2017: Syntel

01/25/2017 6:00 am EST

Focus: STOCKS

Douglas Gerlach

President, ICLUBcentral, Inc.

Bargains are hard to find, but one exception is this mid-cap information technology and business outsourcing company, asserts Doug Gerlach, editor of Investor Advisory Service.

Syntel (SYNT) has been battered in the wake of the election.Investors are worried that the new administration will be unfriendly to an industry that competes with domestic workers.

We think these concerns will prove overblown, as outsourcing companies like Syntel provide essential services that would be very difficult to reproduce using a purely domestic labor force.

About 75% of Syntel's revenue comes from building and maintaining big companies' IT systems. The rest comes from the outsourcing of clerical or administrative tasks like invoice reconciliation or data entry.

Almost 80% of Syntel's billable employees are based overseas, mainly in India. The majority of the remaining workforce relies on work permits or visas to work in the U.S.

This is the big risk to companies like Syntel, whose ability to deliver services globally depend on bringing large numbers of foreign workers to the U.S.

If the new administration restricts work visas, Syntel will have to compensate by training more domestic workers and locating a smaller percentage of its overall workforce in the U.S.

Meanwhile, one of the best things about this business is its free cash flow. For every $1 of revenue the company collected in 2015 it generated $0.21 in free cash flow.

The company has been in somewhat of a growth lull lately, and the market's expectations for SYNT are currently quite low. We think growth will resume as the industry's superior economics ultimately prove insuppressible.

If Syntel can grow earnings per share at 10% per year for five years, EPS could reach $3.87. That multiplied by a high P/E of 16.6 generates a high price of $63, providing a potential 25% annual return if reached.

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