Business services providers play a critical role for enterprises, assisting them with everything from new hardware integrations to consulting and marketing. Still, investors are uneasy as firms face challenges from AI-driven disruptors and tightening corporate budgets. These doubts have caused the industry to lag recently as services stocks have collectively shed 3.1% over the past six months. This performance was discouraging since the S&P 500 held steady.
Investors should tread carefully as many of these companies are also cyclical, and any misstep can have you catching a falling knife. With that said, here are three services stocks we’re swiping left on.
Telephone and Data Systems (TDS)
Market Cap: $3.90 billion
Operating primarily through its majority-owned subsidiary UScellular and wholly-owned TDS Telecom, Telephone and Data Systems (NYSE:TDS) provides wireless, broadband, video, and voice communications services to 4.6 million wireless and 1.2 million broadband customers across the United States.
Why Are We Out on TDS?
- Products and services are facing significant end-market challenges during this cycle as sales have declined by 1.6% annually over the last five years
- Earnings per share have contracted by 24% annually over the last five years, a headwind for returns as stock prices often echo long-term EPS performance
- High net-debt-to-EBITDA ratio of 26× could force the company to raise capital at unfavorable terms if market conditions deteriorate
Telephone and Data Systems is trading at $34.01 per share, or 3x forward EV-to-EBITDA. Dive into our free research report to see why there are better opportunities than TDS.
DXC (DXC)
Market Cap: $3.00 billion
Born from the 2017 merger of Computer Sciences Corporation and HP Enterprise's services business, DXC Technology (NYSE:DXC) is a global IT services company that helps businesses transform their technology infrastructure, applications, and operations.
Why Do We Think DXC Will Underperform?
- Organic revenue growth fell short of our benchmarks over the past two years and implies it may need to improve its products, pricing, or go-to-market strategy
- Falling earnings per share over the last five years has some investors worried as stock prices ultimately follow EPS over the long term
- ROIC of 1.3% reflects management’s challenges in identifying attractive investment opportunities, and its decreasing returns suggest its historical profit centers are aging
At $14.23 per share, DXC trades at 4.9x forward P/E. Check out our free in-depth research report to learn more about why DXC doesn’t pass our bar.
Exponent (EXPO)
Market Cap: $3.95 billion
With a team of over 800 consultants holding advanced degrees in 90+ technical disciplines, Exponent (NASDAQ:EXPO) is a science and engineering consulting firm that investigates complex problems and provides expert analysis for clients across various industries.
Why Do We Steer Clear of EXPO?
- Muted 4.5% annual revenue growth over the last two years shows its demand lagged behind its business services peers
- Modest revenue base of $518.7 million gives it less fixed cost leverage and fewer distribution channels than larger companies
- Diminishing returns on capital suggest its earlier profit pools are drying up
Exponent’s stock price of $77.74 implies a valuation ratio of 37.1x forward P/E. To fully understand why you should be careful with EXPO, check out our full research report (it’s free).
Stocks We Like More
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