To kick things off, let's return to an item from the first column. In 2002, Cognizant's stock-based compensation was $11.6 million. Net income, meanwhile, totaled $34.6 million. Thus, stock-based compensation was 34% of accrual profits. This high number tells me labor costs are understated.

Another red flag is the firm's option overhang. In its latest 10-K, Cognizant had 5.5 million shares outstanding or available for future grants and issuance. With 20.4 million shares, that works out to a 28% overhang. I like to see a much smaller contingent liability, if any. (So you can do the math yourself, these numbers are from the 2002 annual report and do not reflect the recent 3-for-1 split.)

While on this subject, the latest proxy says the board tried to boost the number of shares available for issuance under various incentive plans to 24 million shares (split-adjusted), up from 18 million. With 62 million shares outstanding, this would represent 39% of all shares outstanding. Fortunately, the stockholders said no to such a brassy request. If you are a nonemployee stockholder, this potential dilution is a big negative. (Look for the board to make a similar proposal again next year.)

It also appears that insiders are aggressively selling their stock. Wijeyaraj Mahadeva, Cognizant's chairman, has 98,160 shares, according to Yahoo! Finance, a fraction of the 1.9 million shares held on Mar. 31, 2003. Meanwhile, CFO Gordon Coburn has 3,165 shares, down from 123,645 shares. On the basis of the latest available information, insiders now own slightly more than 0% of the business. No wonder they want more options in the incentive plan!

Cognizant also benefited from a low effective tax rate, which means 2002's GAAP earnings are overstated. Indeed, if the firm were taxed at the 35% statutory rate and also had its stock-based compensation expensed, then 2002's adjusted net income would be $17.7 million -- almost 50% lower than the reported figure.

	2002 (in millions)
Net income, GAAP	$34.6
Less: Stock-based compensation	11.6
Less: Additional taxes to get to statutory rate	5.3
Net income, adjusted	$17.7
Source: Company reports