Cognizant Technology Stock Could Be a Great Way to Profit from AI at a Discount

With artificial intelligence universally recognized as a paradigm-shattering innovation, it’s not surprising that several players in the sphere have enjoyed robust momentum. That’s especially the case now that it appears the world might not succumb to a global depression after all. However, the good vibes just haven’t reached Cognizant Technology Solutions (CTSH).

Perhaps the most obvious point is the technical damage. Since the start of the year, CTSH stock has lost roughly 50% of market value. Over the trailing one-year period, the red ink amounts to more than 45%. Unsurprisingly, this type of performance ignominiously earned Cognizant a Strong Sell rating from the Barchart Technical Opinion indicator.

It’s also fair, though, to point out that many retail traders use such pessimistic signals as a contrarian indicator. Within the financial publication sphere, those who share the glass-half-empty thesis point to the observation that financially, the company appears to be in relatively good shape. Thanks to rising revenue and optimistic management forecasts, there’s an argument to be made that CTSH stock is undervalued.

Personally, I’m not a big fan of declaring securities undervalued simply because they trade at a lower premium compared to some prior benchmark. Even if we were to grant the significant presupposition that CTSH stock is favorably mispriced relative to earnings, it has yet to be proven that the equities market responds linearly to a single, flagship metric.

In other words, the real question isn’t whether CTSH stock is undervalued based on earnings; it’s whether Cognizant is undervalued relative to future business demand. The problem is, future business demand isn’t something that’s knowable. Further, attempting to answer that question somewhat meaningfully would require access to large-scale (and likely proprietary) data that — let’s face it — independent contributors lack.

Still, just because we don’t know something doesn’t mean we can’t attempt to triangulate some useful insight as to what might happen in the near future.

Being Honest About What We Know About CTSH Stock

Recently, I came across an analysis for Cognizant stock that suggested the ticker might be a worthwhile contrarian idea. Basically, it came down to the usual narrative: the financials are decent, something about the potential of AI and how the multiple is incredibly cheap. What was not prosecuted — and what is almost never prosecuted in finpub pieces — is whether the bullish talking points were already priced in.

Here’s the thing. Unless you have compelling evidence to suggest otherwise, you should assume that the share price has already priced in everything. For CTSH stock, the price almost certainly encompasses the AI obsolescence fear, the cheap multiple argument, the institutional positioning, the short interest, the management guidance and any other random junk.

Under this framework, I can’t tell you whether CTSH stock is literally undervalued or not simply based on its cheap multiple because the cheap multiple is already embedded in the price. Indeed, if my argument was solely that CTSH is trading at a cheap multiple, I would have to explain what portion of the share price has not yet included the cheapness of the multiple.

Obviously, I can’t do that because I lack the capacity of interviewing every investor of CTSH stock to determine if they factored in the cheap multiple. What I can do is make observations about Wall Street’s soccer problem: the ball bounces differently on natural grass than it does on artificial turf.

Stated simply, if we presume the same or similar overall sentiment regime, a publicly traded stock should statistically respond differently depending on its current behavioral state. For example, if CTSH stock is coming off a period of bullish momentum, the next future period should be different than if CTSH was operating off a bearish cycle.

That’s what I mean when I reference the soccer problem. The way that a ball travels across natural grass should be different than how it travels across artificial turf. Similarly, a stock that just suffered a consistent downturn should feature a different forward distribution profile than one that enjoyed an optimistic surge.

By observing these tendencies, we can extract meaningful insights — even if we still can’t answer the valuation question.

Getting Down to Some Actionable Insights

Now, the whole point of doing these observations is to determine whether the projected asymmetry deviates meaningfully from a random baseline. For instance, using data from January 2019 onward, if we were to buy a 10-week long position in CTSH stock, the expected median forward distribution would likely place the share price between $41.40 and $43 (assuming a starting point of $41.83).

However, the key point here is that CTSH stock is coming off a bearish sequence. In the last 10 weeks, CTSH only printed two up weeks, thereby leading to an overall negative slope across the period. Under this specific signal, prior datapoints suggest that the median distribution should place the security between $41 and 46 over the next 10 weeks.

Based on these observations, the options trade that would seem to make the most statistical sense is the 40/45 bull call spread expiring Aug. 21. Essentially, the $45 strike is a realistic target as witnessed from prior historical trends. As well, the breakeven price of $42.65 places CTSH stock well within the expected distribution of outcomes.

Of course, it must be stated that this forecast represents an inference rather than a logical deduction. Since the equities market is a non-deterministic system, it is impossible to declare with certainty that CTSH stock will fall within the expected distribution.

Nevertheless, in my opinion, there’s enough variance in the above signal relative to the random baseline that makes a modestly bullish position quantitatively defensible.