The decision by the Federal Reserve to maintain the full level of its large scale asset purchase program at the September 18 FOMC meeting is a sign monetary policy will remain fully behind the goal of normalized labor market conditions. Although non-farm payrolls have been expanding at a 1.5% to 1.6% year over year rate in recent months, the pace of growth and labor market conditions are not meeting the Fed’s goal.
Furthermore, average hourly earnings of production and non-supervisory workers have begun to rise, but remain low adjusted for inflation. Wages were up 2.23% year over year in August compared to a recent low of 1.33% year over year in the summer of 2012. The consumer price index is up about 1.5% over the last year. A healthy labor market recovery would likely see a meaningful rise in inflation adjusted wage growth.
Monetary policy targets job growth:
There is a great debate about the effectiveness of monetary policy in creating economic growth and employment, but the Fed’s mandate is aimed at maximizing employment and generating stable low inflation. With inflation calm, the Fed has the ability to focus its policy on job growth. Real job creation is more likely to come from fiscal policy changes in Washington, but the inability of political leaders to craft a plan and the placement of ideology above job creation leaves the Fed the main policy lever for improving labor market conditions.
Assuming the Fed will work wholeheartedly to bolster job growth, it might be worth focusing on staffing stocks. These stocks are likely to perform well in an expanding job market, and the sector may have the tailwind of Fed policy at its back.
Payroll growth and labor stock trends:
The graphic below displays the relationship between the year over year change in payrolls and the average price of five labor service stocks – Korn Ferry International (KFY), Manpower (MAN), TrueBlue (TBI), Insperity (NSP), and Kforce (KFRC). The stocks were able to perform strongly between the summer of 2002 and early 2006 and between early 2009 and early 2012 when the labor market was showing expanding growth. The stocks have also been able to trade well in recent months on the back of very steady job growth.
It should be noted that the deceleration in payroll growth tended to lead to lower labor services stock prices in 2000 and again in 2006. The lead on the upswing was more mixed with labor services stocks following the gain in job growth in 2003, but ahead of job growth in 2009.
Unemployment claims and staffing stocks:
The graphic following highlights the relationship between staffing stocks and initial unemployment claims. Although job creation has been steady according to the BLS payroll data, unemployment claims have been declining and are near reaching the cycle lows seen in the late 1990’s and mid 2000’s. Staffing stocks were firm in this time period. The claims data is inverted to show strong (weak) staffing stock prices occurring with a drop (rise) in unemployment claims.
One might draw the conclusion that labor stocks could trade with a firm tone if unemployment claims range in the 300,000 to 350,000 area for a prolong period and in a similar fashion to the 2004 to 2007 period.
Although the expansion in the labor market looks mature, the mid 2000 period could service as an analog. Staffing stocks rose, while claims ranged at relatively low levels. Let’s take a look at staffing stocks and try to come up with a potential winner or two.
Diving into the stocks:
There are a number of stocks in the staffing company universe. The table following displays a list of staffing names, their Zacks Rank, and revisions to earnings per share for the current fiscal year over the past 30 days. The table is focused on Zacks Rank #1 (Strong Buy) and Zacks Rank #2 (Buy) stocks, but Kforce, Zacks Rank #3 (Hold), was included for comparison purposes.
KFY has the most positive trend in earnings estimates revisions. MAN is a distance second, while the other names have seen no activity. The up move in estimates for KFY seemed to come in the wake of its profit results.
The company was able to produce a 10% positive earnings per share surprise in the quarter ending July. Market share gains and industry positioning are two factors at work in upward guidance. There has not been a material enough change in economic conditions to spark mass revisions, and the majority of the staffing companies have not provided great insight into operations. This has kept analysts from changing their earnings estimates.
The growth outlook:
Looking at outlook for sales growth, On Assignment (ASGN) is expected to post the strongest results followed by NSP and KFRC. On earnings, TBI and KFRC are projected to see the most vibrant EPS growth.
The valuation picture:
Three measures of valuation were examined for each stock. The table following displays the 12 month forward PE ratio, PEG ratio, and Price to Sales ratio. Generally, valuations are on the rich side of the historical norm. Let’s look at each measure:
(click table to enlarge)
The median 12 month forward PE for the group is 19.45 against a long term median of 17.99. The average premium is 6.4%. KFY is trading at the biggest discount to average and the peer group followed by KFRC and NSP.
The median 12 month PEG ratio for the group is 1.63 against a long term median value of 1.11. The average premium for the group is 47.8%. The sector seems expensive based on its PEG ratio. All the companies with the exception of KFY are trading at a premium PEG ratio to their median. This makes KFY a clear stand out. For review, the PEG ratio is the ratio of a stock’s price to earnings ratio to its earnings per share growth rate. Stocks are seen as “cheap” (“expensive”) if they are trading with a PE ratio below (above) the growth rate.
It should be noted that TBI has posted the strongest premium, but this may be a function of its outlook for strong EPS growth relative to trend. Likewise, KFRC is expected to see high EPS growth in the coming fiscal year and has an elevated PEG ratio despite a relatively tame 12 month forward PE ratio.
On a price to sales basis, all the stocks but KFRC and CTP are trading at a premium to their median ratio. KFRC has a slight discount, while CTP is trading in line with the median. KFY is trading at only at a marginal premium. ASGN and TBI are trading at the largest premiums.
Summarizing valuation:
If a position is assigned to each stock based on its valuation measure relative to its peers and the positions are averaged, KFY appears to be the cheapest firm followed by KFRC, MAN, and NSP. It is a close race between MAN and NSP. KFY had the lowest forward PE, lowest PEG ratio and third lowest price to sales ratio. ASGN had the worst valuation composite.
Combining valuation with earnings:
KFY seems to be the most attractive stock based on valuation and the upward revision to earnings. Furthermore, it is expected to grow its EPS at nearly 19% in the coming fiscal year.
MAN has more attractive valuation than NSP and seems to have stronger upward momentum to earnings estimate revisions (it’s a Zacks Rank #2), but its outlook for earnings growth is less attractive at 11.2%. NSP is expected to see earnings per share growth of 16.6%.
KFRC, Zacks Rank #3, is not seeing an attractive trend in earnings estimate revisions, but the stocks is attractively valued and is expected to see sharp EPS growth of 24.4% in the coming year.
Conclusion:
Based on the Zacks Rank and valuation, KFY looks like the top pick in the staffing group. If you think the Fed will be successful in generating job growth, and the cycle of economic growth has further to expand, staffing names could do a good job for your portfolio.
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