Business Services Stock Outlook - Part 1
The business services sector provides ancillary services to other industries in the market. Hence, the core business of one company in this sector can be a business service for another. Importantly, this dynamism opens the door to many business services' companies.
Notably, business service accounts for a major portion of a country's gross domestic product (GDP) with the gradual shift in the global economy from agriculture to industry and even business services. Therefore, the sector plays a major role in a country's overall development.
Following the election of Donald Trump as the 45 th U.S. President, gross domestic product is now expected to rise from the current projection of about 2.2%. Employment is also anticipated to improve. Also, Trump's "business friendly approaches," expectation of a lower tax rate, softer regulation and inclination toward higher interest rates are likely to favor the sector.
The intensely competitive business services sector must diligently work toward controlling costs and generating higher revenues in order to maintain its profitability. Focus on functions and activities in line its core competence is a prerequisite in reaping the benefits of economies of scale as well as improving competitive positioning.
The fortunes of business service operators are closely linked to the health of the broader economy. Per the U.S. Energy Information Administration (EIA), gross domestic product is estimated to increase in the upcoming quarters too. While in the GDP growth was 1.9% in the ultimate quarter of 2019, the growth momentum is now expected to accelerate by 2.2% in 2017 and 2.6% in 2018.
This improving outlook for the U.S. economy is therefore a net positive for the sector. The bureau presently estimates total industrial production to increase 1.5% in 2017 and 3% in 2018, thus offering opportunities of growth and expansion to business service providers. Moreover, a projected rise in expenditure should support the business service sector.
Economic sensitivity aside, business service companies are quite conservatively managed, with a large number of players sharing excess cash with investors through dividends and share buybacks.
Nonetheless, the business service sector is highly fragmented, with no single service provider enjoying market dominance. Per business reports, the top 50 companies of the sector contribute less than 25% to the overall revenue. However, given the group's unique nature, Zacks has classified it as one of the 16 sectors (the S&P's official GIC classification has only 10 sectors where business services are grouped within the 'Industrials' sector). Notably, with about 3.3% of total market capitalization, the sector is estimated to generate 2.8% the total income in 2017.
Stand-Alone Zacks Sector
This industry covers an array of services that include marketing, consulting, staffing, security, telecommunications, Internet services, logistics and waste handling. In its expanded sense, the U.S. business services sector generates consolidated yearly revenues of about $620 billion, though many companies mentioned below do not strictly fall within the generally accepted definition of the industry.
Within the Zacks Industry classification, we have divided the business world into 16 sectors comprising 60 industries at the medium or M-level and 256 industries at the expanded or X-level. We rank all 256 X-level industries in the 16 sectors based on the earnings outlook of the constituent companies in each industry. This ranking is available in the Zacks Industry Rank page.
The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 257+ industries is by dividing it into positive, neutral and negative categories depending on the Zacks Rank. The outlook for the top one-third of the list (Rank of #88 and lower) is positive, the middle one-third of the list (Rank of #89 to #176) is neutral, and for the bottom one-third (Rank #177 and higher) is a clear negative.
Please note that the Zacks Rank for stocks - the core of our Industry Rank - has an impressive track record, verified by outside auditors, to foretell stock prices, in particular over the short term (one to three months). We have eight X-level industries within the Business Services sector, namely Auction/Valuation Services, Business Information Services, Business Services, Consulting, Financial Transaction Services, Outsourcing, Staffing and Waste Removal Services.
Auction/Valuation Service ranked #22, Business Information Services with a rank #59, Financial Transaction Services having a rank #76 and Waste Removal at #83, are industries that falls in the upper one-third and have a positive outlook.
Staffing at rank #91 and Outsourcing at #164 are positioned in the mid one-third of all Zacks industries and have a neutral outlook.
Business Services at #195 and Consulting at #209 are the ones that fall in the lower one-third and have a negative outlook.
Our top pick from the Auction/Valuation industry is Copart, Inc. (CPRT) and Liquidity Services, Inc. (LQDT), which sports a Zacks Rank #2 (Buy). We favor S&P Global Inc. (SPGI) and TransUnion (TRU) carrying Zacks Rank #2 from Business Information Services. Envestnet, Inc. (ENV) flaunting Zacks Rank #1 (Strong Buy), and Total System Services, Inc (TSS) and Visa Inc. (V), both of which carry a Zacks Rank #2, are our top picks from Financial Transaction Service industry. From business information service we have picked S&P Global Inc. (SPGI), which flaunts a Zacks Rank #1. You can see the complete list of today's Zacks #1 Rank stocks here .
Expensive Valuation of the Business Service Sector
The valuation of the business service sector seems expensive. The Business Service sector is currently trading at 10.6X EV/EBITDA multiple. This is expensive when compared to its own traded multiple (trading near its high end of 11.11x and median of 10.47x) in the last one year as well as S&P 500 (10.15x). Shares of the sector also underperformed the S&P 500 in the last one year period.
Infact the sector ranks at bottom 38% of our Zacks Sector classification.
Earnings Review & Outlook
The fourth-quarter earnings season is at its peak with 82.6% of business service providers having already reported their numbers. The sector's earnings witnessed 12.1% growth on 3.1% revenue improvement. The bottom line compared favorably with the numbers delivered by the S&P 500 (6.1% earnings increase) though the top line compared unfavorably with the index (4.6% revenue growth). Beat ratio of 68.4% for earnings was weaker than the S&P 500.
Overall earnings for the fourth quarter are estimated to increase 10.8% for the sector compared with a 7.5% increase for the S&P 500. Revenues, on the other hand, are expected to exhibit growth of 7.5% compared with 3.9% for the S&P 500.
For full-year 2016, earnings for the business service sector are estimated to increase 3.0% on 3.4% revenue growth. This compares favorably with the S&P 500's expected earnings decline of 2.4% with revenues likely to inch up 0.7% from the 2015 level.
Notably, our Earnings Trend report shows that Business Service is one of the most impressive sectors in terms of positive growth.
Looking ahead, earnings for the business service sector are estimated to increase 10.9% on 3.7% revenue improvement for 2017. This compares unfavorably with the S&P 500's expected earnings growth of 12% but is better than the estimated revenue improvement of 3.6% from the 2016 level.
The graph below shows year-over-year bottom-line growth of the business service (BS) sector in comparison to the S&P 500.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.