The consulting services industry is benefiting from overall strength in manufacturing and non-manufacturing activities backed by all-around strength in the economy.
Economic activity in the manufacturing sector expanded in May as Purchasing Managers' Index (PMI) measured by Institute of Supply Management (ISM) touched 58.7%. This shows strong growth in manufacturing for the 21st consecutive month, driven by continued increase in new orders, production activity and employment.
The ISM non-manufacturing index (NMI) was 58.6% in May, recording the 100th consecutive month of expansion. The expansion was driven by continued increase in business activity, new orders, employment, inventories, prices and supplier deliveries.
Out of the 18 non-manufacturing industries, 14 reported growth. The Non-Manufacturing Business Activity Index registered growth of 61.3% in May, up 2.2% from the April reading of 59.1%, growing for the 106th consecutive month.
However, higher talent costs due to a competitive talent market coupled and Trump’s stringent policies on immigration are hurting consulting services stocks. The industry is labor intensive and heavily dependent on foreign talent. Moreover, while advancement in automation and AI offer massive opportunity to the industry, these technologies enable clients to comprehend and integrate new methods to improve performance, thereby creating uncertainty for consulting services firms.
Industry Outpaces Sector and S&P 500’s Yield
Looking at shareholder returns over the past year, it appears that the border economic recovery is enhancing investors’ confidence in the industry.
The Zacks Consulting Services Industry, which is a stock group within the broader ZacksBusiness Services Sector, has outpaced the S&P 500 and its own sector in the past year.
While the stocks in this industry have collectively gained 24.5%, the Zacks S&P 500 Composite and Zacks Businss Services Sector have rallied 12% and 19.1%, respectively (the blue line in the chart below represents the industry).
One-Year Price Performance
Consulting Services Stocks Look Expensive
The share price rally in the past year has, however, led to a relatively rich valuation.
Comparing the industry to the S&P 500 on the basis of price to forward 12 months’ earnings, we see that the industry’s 22.2X is ahead of the S&P 500’s 16.7X. It is ahead of the sector’s 22.3X.
Price to Forward 12 Months
Comparing the industry to the S&P 500 on the basis of price to forward earnings growth, we see that the industry’s 2.1X is again ahead of the S&P 500’s 1.8X. It is also ahead of the sector’s 2X.
Price to Forward Earnings Growth
Price to EBITDA
Comparing the industry to the S&P 500 on the basis of price to EBITDA, we see that the industry’s 12.34X is again ahead of the S&P 500’s 12.33X. It is also ahead of the sector’s 11.7X.
So any way you cut it, the industry is overvalued.
Improving Economy Confirms Near to Mid-Term Outperformance
The macroeconomic drivers such as improving economy, reduced tax rates, robust manufacturing and non-manufacturing activity, and higher government spending are likely to offset operating challenges encountered by the industry.
But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. The earlier valuation discussion shows that market participants are willing to pay up for these stocks already, potentially limiting further upside from current levels.
One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.
Price and Consensus: Zacks Consulting Services Industry
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $4.26 EPS estimate for the industry for 2018 is not the actual bottom-up EPS estimate for every company in the Zacks Consulting Servicesindustry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the earnings of the industry for 2018, but how this number has evolved recently.
As you can see here, the $4.26 'EPS' estimate for 2018 is up from $4.13 this time last year. In other words, the sell-side analysts covering the companies in the Zacks Consulting Services have been steadily raising their estimates.
Zacks Industry Rank Indicates Gloomy Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.
The Zacks Consulting Services industry currently carries a Zacks Industry Rank #198, which places it at the bottom 23% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Our proprietary Heat Map shows that the industry’s rank has continually deteriorated over the past four weeks.
Industry Promises Long-Term Growth
While the near-term prospects do not look welcoming for investors, the long-term (3-5 years) EPS growth estimate for the Zacks Consulting services industry appears promising. The group’s mean estimate of long-term EPS growth rate is at the current level of 11.4%. This compares to 9.8% for the Zacks S&P 500 composite.
Mean Estimate of Long-Term EPS Growth Rate
In fact, the basis of this long-terms EPS growth could be the recovery in the top line that the Zacks Consulting Services industry has been showing since the beginning of 2004.
Revenues: Zacks Consulting Services industry
A strong U.S. economy, reduced tax rates, robust manufacturing and non-manufacturing activity and higher government spending should support growth of the industry in the long run. However, a strong labor market, shortage of skilled labor and Trump’s strict rules on immigration will make things difficult for the industry that is heavily dependent on the foreign talent market.
Since the near-term prospect of the industry does not appear encouraging, it would be prudent to stay away from some weak stocks that are likely to underperform.
Huron Consulting Group Inc. (HURN - Free Report) : The stock of this IL-based a professional services firm has gained 0.7% in the past six months, underperforming the industry’s rally of 3.5%. The Zacks Consensus Estimate for current-year EPS was revised 0.9% downward in the last 60 days. The stock carries a Zacks Rank #4 (Sell).
One-Year Price Performance: HURN
Cynergistek, Inc. (CTEK - Free Report) : The stock of this CA-based outsourced document solutions, IT consulting data security, and managed print services provider shed 1.3% of its value in the past six months. The Zacks Consensus Estimate for current-year EPS was revised 23.5% downward in the last 60 days. The stock carries a Zacks Rank #4.
One-Year Price Performance: CTEK
However, keeping the long-term expectations in mind, investors may look for some good entry points that will help them make the most of the momentum in the industry.
CBIZ, Inc. (CBZ - Free Report) : The stock of this OH-based provider of professional business services has gained a massive 47.9% in the past six months. The Zacks Consensus Estimate for the current-year EPS was revised 4.8% downward in the last 60 days. The stock carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
One-Year Price Performance: CBZ
NV5 Global, Inc. (NVEE - Free Report) : The stock of this FL-based provider of professional and technical engineering and consulting services has gained 26.7% in the past six months. The stock carries a Zacks Rank #2.
One-Year Price Performance: CBZ