3 Business Services Stocks to Top Q3 Earnings as Fed Ends QE - Earnings ESP

With an overall improvement in the broader economy and a favorable labor market outlook, the Fed took a pragmatic step to end the Quantitative Easing (QE) program effective next month. However, despite an erratic equity market and global turbulence arising from geopolitical issues, the Fed vouched to continue with the near-zero interest rates for a “considerable time”.

As factory output increased and consumer confidence surged, indications were clear that the economy was back on track bereft of any economic stimulus. However, the near-term inflation was expected to remain tempered by falling energy prices, although the long-term outlook was deemed to be stable.

The positive vibes gain traction from the underlying strengths of the third-quarter earnings season unfurled so far. The relatively modest earnings picture gives us enough confidence that the feel-good factor is not an aberration. Rather, it is surely here to stay.       

At the halfway mark, with 287 S&P 500 members having reported third-quarter results as of Oct 29, the composite earnings scenario appears a mixed bag. With a ‘beat ratio' (percentage of companies coming out with positive surprises) of 71.8% and a median surprise of +2.9%, total earnings for these companies are up +6.5% year over year. Top-line growth has aggregated +5.1% compared with the year-ago period, with a healthy revenue ‘beat ratio' of 53.7% and a median surprise of +0.5%.

Although the revenue growth performance compares favorably with the recent past (up +5.1% vs. +4.9% in the second quarter and the average of +3.5% over the preceding four quarters), the earnings growth performance for the already-reported companies appears disheartening (up +6.5% vs. +8.3% in the second quarter and the average of +7.6% over the preceding four quarters).

The current expected third quarter earnings growth for the S&P 500 (combining the results from the 287 companies that have reported with estimates for the remaining 213) is pegged at +4.9% with revenues anticipated to expand by +2.9%. This include a double-digit earnings improvement in the Construction sector (+15.1%), Basic Materials (+15.0%), Medical (+13.5%), Business Services (+12.3%) and Transportation (+10.3%). 

Most of this growth is attributable to a steady yet improving U.S. job market as the unemployment rate declined to a six-year low of 5.9% in September with 248,000 jobs added across all sectors of the economy. For the first nine months of 2014, employers have added an average of 227,000 jobs a month, up from an average of 194,000 last year. The economy reportedly gained an estimated 2.64 million jobs in the past 12 months, the best annual performance since Apr 2006.

The U.S. GDP grew at an annualized rate of 3.5% in the third quarter as business investment improved steadily and trade deficit narrowed. Government outlays also witnessed a dramatic improvement with the loosening of purse strings for defense spending, which rose the fastest since second quarter 2009. Consequently, the outlook for the U.S. economy appears to be on firm footing and is likely to exceed the International Monetary Fund's

2.2% GDP growth expectations in 2014 and that of 3.1% in 2015. Commensurate with these expectations, earnings for the S&P 500 are expected to be up 6.8% in 2014 and a further 10.9% in 2015.

Amid these positive feelers, most companies in the Business Services industry remain bullish. The primary growth drivers in this highly fragmented industry hinge on a healthy economy with decent job growth prospects, higher disposable income and new business initiatives. An ideal mix of services, effective marketing strategies and ability to retain and attract new customers make the perfect recipe for profitability for most of these companies.

As infrastructure and capital goods order picked up, most companies have joined the bandwagon to look for potential inorganic and organic growth opportunities. Thus the Business Services sector is expected to outperform the overall equity market with an earnings growth expectation of 12.3% in the third quarter versus 4.9% for the S&P 500 index.

Given the promising forecast, it might be a good idea to zero-in on a handful Business Services stocks that are poised to beat earnings estimates this quarter. An earnings surprise should help these stocks outperform in the near term.

The Business Services sector covers an array of services that include marketing, consulting, staffing, security, telecommunications, Internet services, logistics and waste handling. Amid a diverse range of companies in the Business Services arena, picking the right stock for your portfolio could appear to be a colossal task. An easy way to narrow down the list is to look at stocks that have a solid Zacks Rank and a favorable Zacks

.

Earnings ESP is our proprietary methodology for determining which stocks have the best chance to surprise with their next earnings announcement. The Earnings ESP shows the percentage difference between the Most Accurate Estimate and the Zacks Consensus Estimate.

The combination of a Zacks Rank #1 (Strong Buy) or #2 (Buy) or #3 (Hold) and a positive Earnings ESP is usually a harbinger of an earnings beat and serves a perfect success formula on platter. Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.

For investors seeking to benefit by applying this strategy to their portfolios, we have mentioned three Business Services stocks below, which match these criteria, and thus may be potential winners this earnings season.

: Headquartered in Boca Raton, FL, ADT offers electronic security products along with a wide range of interactive home and business automation and monitoring services for residences and small businesses in the U.S. and Canada. Founded in 1874 as a telegraph delivery company, it has traversed time through a rollercoaster ride, changing its business and ownership across the years before finally getting listed as a standalone company in late 2012.

The company is anticipating decent quarterly earnings, which is expected to be up 7.0% year over year with the current Zacks Consensus Estimate pegged at 49 cents. ADT currently carries a Zacks Rank #3 along with an Earnings ESP of +4.08%. The company is expected to report its fourth quarter fiscal 2014 results before the opening bell on Nov 12.

: Headquartered in Stamford, CT, Gartner is a premier global information technology research and advisory company, delivering technology-related insight necessary for an informed decision-making process for its clients. Founded in 1979, Gartner has 6,600 associates, including over 1,500 research analysts and consultants, and clients in 85 countries.

The company has a long-term earnings growth expectation of 17.5%. Gartner currently has a Zacks Rank #3 along with an Earnings ESP +2.56%. The company is slated to report its third-quarter 2014 results before the market opens on Nov 6.

: Founded in 2003, RealD is a leading global licensor of 3D and other visual technologies, offering an extensive intellectual property portfolio that enable a premium viewing experience in the theater, home and elsewhere. Headquartered in Beverly Hills, CA, the 3D technologies of the company are also utilized by Fortune 500 companies, government, academic institutions, and research and development organizations for various applications, as well as theme park installations.

The company has a long-term earnings growth expectation of 30.0%. RealD currently has a Zacks Rank #3 along with an Earning ESP of +22.22%. The company is scheduled to report its second-quarter fiscal 2015 results after the market closes on Nov 3.

Anthony Karydakis, chief economic strategist at Miller Tabak in New York observed: "The solid pace of manufacturing activity in recent months is not going away any time soon". As the U.S. stocks look to gain solidarity with a healthy rebound in the economy, a sneak peek to the space for some possible outperformers backed by a solid Zacks Rank and a positive Zacks Earnings ESP could be a great idea for investors to gain from this earnings season.

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