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, helping them benefit from operating efficiencies. Many of these functions fall within otherwise ancillary areas for most companies -- for example, payroll processing, staffing, marketing/advertising and information technology, to name some of the major areas.
The outlook for these businesses moves in-line with the broader economy, with the business-friendly orientation of the current administration widely expected to give the U.S. economy a growth nudge.
Per the U.S. Energy Information Administration (EIA), gross domestic product is estimated to increase in the upcoming quarters, too. GDP growth is now expected to accelerate 2.1% in 2017 and 2.6% in 2018. This favorable outlook for the U.S. economy is a net positive for the business service sector as well. No doubt, the sector has been a strong performer this year, with the Zacks Business Services sector up +10.9% in the year-to-date period, roughly in-line with the S&P 500 index’s +11.4% gain.
The intensely competitive business services sector must diligently work toward controlling costs and generating higher revenues in order to maintain profitability. Focus on functions and activities in line with core competence is a prerequisite in reaping the benefits of economies of scale, as well as improving competitive positioning.
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. Another attribute of the sector is its highly fragmented nature, with no single service provider enjoying market dominance. Per business reports, the top 50 companies of the sector contribute less than 25% to the sector’s total revenue.
Stand-Alone Zacks Sector: Favorable
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 11 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 S&P 500 income in 2016.
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 (M-level) and 265 industries at the expanded (X-level). We rank all 265 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.
We rank the 265 sub-industries in the 16 Zacks sectors based on earnings outlook and fundamental strength of the constituent companies in each industry. We put our industries into two groups — the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank). Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than two to one. To learn more visit: About Zacks Industry Rank.)
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 #32, Business Information Services at #36, Financial Transaction Services at #51 and Consulting at #71 fall in the top half.
Waste Removal at #175, Business Services at #181, Staffing at #194 and Auction/Valuation Services at #231 are industries that fall in the bottom half.
Our top picks from the Outsourcing industries are Atento S.A. (ATTO - Free Report) and Broadridge Financial Solutions, Inc. (BR - Free Report) , both carrying a Zacks Rank #1 (Strong Buy).
Bureau Veritas SA (BVRDF - Free Report) and CBIZ, Inc. (CBZ - Free Report) , carrying a Zacks Rank #1 are our top picks from the Consulting industry.
The Dun & Bradstreet Corp. (DNB - Free Report) and FactSet Research Systems Inc. (FDS - Free Report) , carrying a Zacks Rank #2 (Buy), are our favorites from the Business Information Services.
Green Dot Corporation (GDOT - Free Report) with a Zacks Rank #1, and Mastercard Inc. (MA - Free Report) , Visa Inc. (V - Free Report) , Total System Services, Inc. (TSS - Free Report) and The Western Union Company (WU - Free Report) – all carrying Zacks Rank #2 -- are our favorite picks form Financial Transaction Services industry.
Nevertheless, the sector is among the top 50% of our Zacks Sector classification.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Valuation of the Business Service Sector
The valuation of the business service sector seems attractive relative to its own history as well as the broader S&P 500 index.
The Zacks Business Service sector is currently trading at a trailing 12-month EV/EBITDA multiple of 9.4X. Over the last 5 years, the sector has traded as low as 8.6X and as high as 12.8X, with a median of 10.6X. In other words, the sector is currently trading below the 5-year median on a trailing 12-month EV/EBITDA basis.
On a forward 12-month EPS basis, the sector is currently trading at 20.5X, which compares to the 5-year range of 15.2X and 20.8X, with a 5-year median of 19.3X. In other words, the sector is trading towards the high end of its 5-year forward 12-month P/E range.
The sector is trading at a discount to the S&P 500 index on the trailing 12-month EV/EBITDA basis.
The sector modestly underperformed the S&P 500 index in the last one year period. While the sector gained +11.9%, the index gained +15.6%.
Earnings Review & Outlook
Earnings of the business service sector in the second quarter witnessed 11.1% growth on 4.4% revenue improvement. While bottom-line growth was in line with the S&P 500, top-line growth was shade below index’s performance.
Companies will start reporting third-quarter earnings in the next few weeks. Earnings are expected to be breakeven, while revenues will grow 2.9%. Both compare unfavorably with the S&P 500.
For full-year 2017, earnings for the business service sector are estimated to increase 9.4% on 5.4% revenue growth. This compares favorably with the S&P 500’s expected earnings increase of 7.5% on 4.6% higher revenues from 2016.
For full-year 2018, earnings for the business service sector are estimated to increase 12.1% on 5.7% revenue growth. This compares favorably with the S&P 500’s expected earnings increase of 11.0% on 5.1% higher revenues from 2017.
Notably, our Earnings Trend report shows that Business Service 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 Services sector in comparison to the S&P 500.
The graph below shows year-over-year top-line growth of the Business Services sector in comparison to the S&P 500 index.
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