The market might have stumbled a bit lately, but it has been less than a glancing blow for red-hot stocks in the management services and consulting sector.
And given the strong fundamentals, some of these under-the-radar names look to have more upside ahead — despite valuations that are looking a bit stretched.
Apart from Accenture (ACN), the $53 billion market cap behemoth, most firms in the consulting and services sector garner little attention — except, of course, by those shareholders enjoying some market-crushing returns.
From healthcare reform to Chinese hackers to corporate cost-cutting, there is no shortage of factors driving strong growth prospects for services providers and consultants. Here’s a look at three of the more promising names in an often-overlooked sector.
Booz Allen Hamilton
Booz Allen Hamilton (BAH) derives most of its revenue as a government contractor, supplying cybersecurity expertise to a wide swath of Federal agencies, including the Department of Defense, Treasury and EPA.
Fears that the sequester would hurt revenue led BAH to underperform the S&P 500 for most of the year — but those fears appear to have been overblown.
BAH easily topped Wall Street’s earnings forecast on Wednesday, helped by new contracts with the Pentagon, NASA and the Department of Homeland Security. Shares popped on the news, no doubt helped in part by a short squeeze. Nearly 11% of the float was sold short as of the end of April, according to data from S&P Capital IQ.
Regardless, the stock is now up 33% for the year to date, beating the broader market by a whopping 17 percentage points. That has the valuation looking a bit hot: BAH’s forward price-to-earnings is up to 12 vs. its own five-year average of 10.
But given a long-term growth rate of 11.2% and the 2.2% dividend, that multiple expansion seems more than warranted. BAH also is cheap relative to the broader market, which sports a forward P/E of 15 despite a growth forecast of less than 10%.
Unlike BAH, Genpact (G) looks definitively cheap on a relative valuation basis. Spun out of General Electric (GE) back in 2007, the company handles everything from accounting services to supply chains for industries as varied as banking, aerospace and logistics.
With the sluggish global economy making corporate revenue growth nearly impossible to come by, Genpact’s 400-plus clients need to squeeze every basis point of savings out of their cost structures.
That has helped propel shares to a 25% gain in 2013 vs. a 16% increase for the broader market. And yet, by some measures, the stock still looks like a bargain.
The forward P/E of 16.5 offers a 12% discount to its own five-year average, according to data from Thomson Reuters Stock Reports. Paying less than 17 times forward earnings seems more than reasonable given Wall Street’s forecast that Genpact will grow earnings by an average of 15% a year over the next five years. Remember: The S&P 500 currently fetches 15 times forward earnings for a growth rate of just 9.4% over the same period.
Plenty of businesses are freaking out about federal healthcare reform and generalized economic uncertainty. Not Towers Watson (TW). For this company, it has been something of a boon.
TW takes care of functions like corporate benefits, risk and finance services, and technology and administrative duties — normal management services and consulting stuff.
But the outsized opportunity looks to be in its Exchange Solutions segment, which operates private health insurance exchanges for employer-sponsored coverage for corporate employees and retirees.
It also doesn’t hurt the bull case that TW has a long history of exceeding analysts’ profit expectations. Indeed, the firm has topped Wall Street’s bottom-line estimates every quarter for more than two years.
That all adds up to a stock that has gained 40% year-to-date, beating the broader market by 24 percentage points. And yet Towers’ valuation, while not a screaming bargain, still looks reasonable given forecast earnings growth.
The forward P/E of 13.5 is higher than TW’s own five-year average of 12.5, but again, that multiple expansion seems warranted given a long-term growth rate of 10.5% — more than a full percentage point better than that of the S&P 500.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.