The Best American Business Services Provider

Awais is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In current times, where companies have the objective of exploiting their core competence at the focal point, this need opens the door to opportunities for the providers of business services.

The business service industry caters to demands that include marketing, consulting, staffing, security, telecommunications, internet services, logistics and waste handling.

Eventually, demand is based on business spending, which in turn is determined by the financial health of the overall economy. Individual company profits depend on efficient operations and effective marketing. Large companies are able to reap the advantages of economies of scale, and can compete for big, national accounts. Small companies can focus on highly specialized services or a market niche, or via advanced customer service. The U.S. business services sector is highly fragmented: the 50 largest companies comprise less than a quarter of sector revenue. The U.S. business services sector produces an annual revenue of $620 billion. No one business services provider has a sufficiently large market share to dominate the industry, or affect pricing decisions.

Company analysis

Global Payments (NYSE: GPN), Automatic Data Processing (NASDAQ: ADP) and Fiserv (NASDAQ: FISV) deserve scrutiny from an investment stance. Let's identify the best return generating stock in the following report.

Source: Morningstar

The business service sector industry grew at a rate of 6.5% in the preceding years of the economic downturn. Global Payments registered a double-digit growth of 14.7% in its top line, surpassing its peers, followed by ADP whose revenue results were equivalent to the industry, while Fiserv lagged behind the others. Net margin exhibited a different pattern of results, with Global Payments posting excellent returns on the face of it. However, a one-time pre-tax impairment charge of $147,664 in fiscal 2009, pertaining to the money transfer business, caused net income to decline drastically in FY09. Thus, in FY10, net income resumed to normal levels, giving the impression of extraordinary growth. ADP was unable to translate its revenue growth into net margin growth in an effective manner, while Fiserv was slightly performing above the industry.

Source: Morningstar

Overall, the ROE components of ADP depict the company to be a cut above the industry and its competitors, with an all-equity financed capital base. However, the other two companies have employed leverage more than the industry standard. To some extent, it provides them the opportunity to take advantage of tax benefits of debt financing and successful employment of cost management as exhibited in Fiserv’s net income margin.

Global Payments had the lowest ROE among its rivals, although it was higher than the overall industry due to the costs associated with the processing system intrusion and, to a lesser extent, the effect of U.S. ISO business. During the year, the company identified and self-reported unauthorized access into a limited portion of the North America card processing system. As a result of this event, certain card brands removed the company from their list of PCI DSS compliant service providers.

Comparative valuation

The weighted average value of the stock symbolizes its calculated fair value. For computing the weighted average value of the stocks with the multiples-based approach employed, more weight is assigned to the multiples that give a better picture of the economic reality of the company. The industry standard is also taken into account.

Compared to the current market price of each stock, Global Payments and Fiserv appear to be undervalued relative to the market, whilst ADP is relatively overvalued. Based on current market statistics, Global Payments has a positive potential of 25.52% and Fiserv is projected to give a return of 10.07% whereas ADP is projected to report negative returns of 17.22%.

Future prospects

On the grounds of the above analysis, Global Payments seems to provide the maximum return on investment. However, my opinion differs; I support the purchase of Fiserv, due to the positive figures the company has shown in all areas, though the company’s growth and margins were lower in preceding years. Nonetheless, Fiserv continues to improve its bottom-line results. In the light of future growth prospects, and the comparable valuation performed, I would advise going long on Fiserv in order to earn a positive portfolio return.

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Awais Iqbal has no position in any stocks mentioned. The Motley Fool recommends Automatic Data Processing. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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