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Outlook for Computer IT Services Industry Remains Cloudy

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The Zacks Computer – IT Services industry comprises an array of companies that provide consultancy, customer relationship management (CRM), communications, IT management & operations, cloud-based web development platform, professional information solutions and outsourcing services.

The industry participants primarily cater to diversified end-markets and customer base which constitute manufacturing, banking, insurance, healthcare, government agencies and public sectors.

In a bid to modernize legacy-oriented business processes, most of the industry participants are in the process of restructuring their traditional services. The goal is to assimilate the synergies of emerging technologies, including the likes ofcloud, Internet of things (“IoT”), artificial intelligence (“AI”) and analytics, to name a few. The industry is witnessing higher debt levels, R&D and sales & marketing spending owing to these factors, which in turn is limiting profitability.

Here are the three major themes in the industry:

  • The industry’s growth is expected to accelerate in the near future on the back of ongoing workspace trends of Bring Your Own Devices (“BYOD”) and increasing mobile workers. Small and medium enterprises remain key beneficiaries in this domain amid the digital transformation era. Enterprises are increasingly seeking to find a common ground between on-premise and cloud infrastructures that enable them to provide flexible easily adoptable hybrid solutions. Further, increasing IT-spending trends bodes well for the industry players.
  • Increasing U.S. protectionism is limiting the industry’s growth prospects. Lack of skilled workers particularly from STEM (Science, Technology, Engineering and Mathematics) fields in the United States has been hindering industry participants for quite some time. In this regard, we may note that the U.S. government’s plan to reduce the issuance of H1-B visas to foreign nationals particularly from countries like India remains a key concern.
  • The ongoing trade war between the United States and China has created an uncertain environment that is not conducive for investments, particularly on infrastructure related services. The tariffs of 10% on an additional $200 billion worth of Chinese goods announced in September has only aggravated the matter. Additionally, volatility in foreign exchange primarily due to current macro-economic scenario and headwinds in the emerging markets does not bode well for the industry.

Zacks Industry Rank Indicates Bleak Near-Term Prospects

The ZacksComputers - IT Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #152, which places it at the bottom 41% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. 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.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings growth potential. Since Mar 31, 2018, the industry’s earnings estimates for the current year have decreased 1.8%.

We will present a few stocks that are well poised to outperform the market despite this weak backdrop, but it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Outperforms Sector and S&P 500

The Zacks Computers - IT Services Industry has outperformed the Zacks S&P 500 composite as well asthe broader Zacks Computer and Technology sector in the past year.

The industry has gained 12.7% over this period compared to the S&P 500’s rise of 2%. On the other hand, the broader sector has declined 5.5%.

One Year Price Performance

Industry’s Current Valuation

On the basis of EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio, which is a commonly used multiple for valuing Computers - IT Services stocks, the industry is currently trading at 25.35X, higher than the S&P 500’s 10.22X and the sector’s 9.57X.

Over the past five years, the industry has traded as high as 33.11X, as low as 21.92X and recorded a median of 27.57, as the charts below show.

Enterprise Value/EBITDA Ratio (TTM)

Enterprise Value/EBITDA Ratio (TTM)

Bottom Line

Increasing internet penetration rates in the emerging markets, particularly across Asia-Pacific, rising IT-infrastructure spending, and focus on providing hybrid solutions remain primary catalysts for the industry players.

Here, we present three stocks that carry a Zacks Rank #2 (Buy) and are well positioned to grow in the near term. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Headquartered at Newtown, PA, EPAM Systems, Inc. (EPAM - Free Report) is engaged in providing services pertaining to software product development, custom application development, application testing, application maintenance and support, infrastructure management and enterprise information management.The stock has gained 15.5% in the past year. The Zacks Consensus Estimate for current fiscal year ESP has increased by a penny to $4.28 over the past seven days.

Price and Consensus: EPAM

Lincolnshire, IL-based CDW Corporation (CDW - Free Report) offers integrated IT solutions to enterprises, government agencies, healthcare, and education customers across the United States, the U.K. and Canada. The stock has returned 30.8% in the past year. The Zacks Consensus Estimate for its current fiscal year EPS has increased by 1.4% to $5.04 over the past 30 days.

Price and Consensus: CDW

CoStar Group, Inc. (CSGP - Free Report) , based out of Washington, DC, offers analytics, information, and online marketplace platform to commercial real estate companies. The stock has gained 21.3% in the past year. The Zacks Consensus Estimate for current fiscal year EPS has increased by 1% to $7.99 over the past 60 days.

Price and Consensus: CSGP


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