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The business services sector includes companies that provide ancillary services to other industries in the market. Companies from this sector help other firms focus on their core competencies and enjoy competitive advantages, aiding margin expansion and the capture of higher market share. This, in turn, boosts the operations of these business services companies.

Notably, business services account for an ever-growing portion of a country’s gross domestic product (GDP) as the economy shifts over time from agriculture to industry and even business services. Therefore, the sector plays a major role in any country’s overall development.

Fortunes of the sector are closely linked to the health of the U.S. and global economy. The outlook for the U.S. economy remains favorable, with the policy expectations from the Trump administration looking to give the growth trajectory a positive nudge. These include increased government spending on infrastructure and defense, tax reforms and business-friendly regulations.

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 3.4% of total market capitalization, the sector generated 2.8% the total income in 2016.

Stand-Alone Zacks Sector

This industry offers 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 of these companies 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 252+ 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.

Outsourcing at #40, Business Information Services at #55, Waste Removal at #61 and Staffing at #63 are industries that fall in the upper one-third and have a positive outlook.

Consulting at #98 and Financial Transaction Services at #101 are positioned in the mid one-third of all Zacks industries and have a neutral outlook.

Business Services at #193 and Auction/Valuation Services at #206 are the ones that fall in the lower one-third and have a negative outlook.

This points to positive to neutral outlook for the business services sector overall. The sector is currently ranked 6th of the 16 Zacks sectors. You can see the Business Service sector’s placement on our sector heat map here >>>

Our top picks from Business Information Services are National Resource Corp. (NRCIA - Free Report) and Recruit Holdings Co., Ltd. (RCRRF - Free Report) , both of which carry a Zacks Rank #1 (Strong Buy).

Republic Services, Inc. (RSG - Free Report) , Waste Management, Inc. (WM - Free Report) and Advanced Disposal Services, Inc. (ADSW - Free Report) have a Zacks Rank #2 (Buy), and are our favorites in Waste Removal.

The Brink's Company (BCO - Free Report) and StarTek, Inc; (SRT - Free Report) from Outsourcing have Zacks Rank #1s, and are our top picks in that group.

We favor Kelly Services, Inc. (KELYA - Free Report) , sporting a Zacks Rank #1, in the Staffing industry.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Expensive Valuation of the Business Service Sector

The Zacks Business Service sector, one of the 16 economic sectors, has underperformed the S&P 500 index over the trailing 12-month and year-to-date periods; the sector is up +8% over the past year vs. the index’s +15.6% gain.

Despite this underperformance, the sector’s valuation isn’t cheap. The Business Service sector currently trades at 20.7X forward 12-month consensus EPS estimates, which compares to the sector’s 5-year range of 14.8X and 21X and median of 19.4X. As such, the current valuation multiple is above the 5-year median.

Earnings Review & Outlook

Earnings of the business service sector in the first quarter witnessed 10.2% growth on 3.9% revenue improvement. However, both the top and bottom line compared unfavorably with the figured reported by the S&P 500 (13.5% earnings increase on 7.2% higher revenues). The beat ratio of 69.6% for earnings and 60.9% for revenues was weaker than the S&P 500.

For full-year 2017, earnings for the business service sector are estimated to increase 8.3% on 4.7% revenue growth. This compares favorably with the S&P 500’s expected earnings increase of 7.7% on 4.1% higher revenues from 2016.

Notably, our Earnings Trends report shows that Business Services is one of the most impressive sectors in terms of positive growth.

The graph below shows year-over-year bottom-line growth of the business service (BS) sector in comparison to the S&P 500.

The graph below shows year-over-year top-line growth of the BS sector in comparison to the S&P 500.

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