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Increased adoption of cloud computing and other emerging technologies, operational efficiency, and reduced expenses in the wake of the coronavirus crisis-induced work-from-home wave have combined to drive a competitive advantage. These factors bode well for the Zacks Outsourcing industry.

Automatic Data Processing, Inc.(ADP - Free Report), Paychex, Inc. (PAYX - Free Report), and Genpact Limited (G - Free Report) are some stocks that are likely to gain from these industry trends. However, rising data security issues, thanks to increased dependency on technology, are concerns for the industry.

Industry Description

Outsourcing is the practice of transferring control of certain operations, services, or processes, previously done by the company’s internal staff and resources, to external resources or third-party contractors to improve operating efficiency by focusing on core business competencies.

The Zacks Outsourcing industry comprises companies engaged in providing human capital management solutions, business management solutions, and information technology solutions for human resources, payroll, benefits, and retirement and insurance services to small- and medium-sized businesses.

Some industry participants also provide business process services with capabilities in transaction-intensive processing, analytics, and automation in the United States and abroad.

What's Shaping the Future of the Outsourcing Industry?

A Healthy Demand Environment: Increasing demand for expertise in improving efficiency and reducing costs has benefited the industry over the past several years. The industry has witnessed growth in revenues, income, and cash flow over the past few years, enabling most players to pursue acquisitions and pay out stable dividends.

Rising Dependency on Technologies: Most of the industry participants are also considering emerging technologies such as cloud computing to drive competitive advantage, increase innovation, improve speed to market, and drive performance within the industry.

The wider application of artificial intelligence (AI) is expected to be the biggest change induced by the pandemic. The adoption of AI should lower complications and simplify operations. This should aid the industry. Notably, industry players are in the process of modernizing their traditional legacy-oriented business processes in order to keep themselves flexible in any kind of operating environment.

Growing Security Issues and Remedies: COVID-19-led increased dependency on technology has led to growing cases of hacking, identity theft, and malicious payload deliveries. With work-from-home models being the new-normal professional scenario, remote infrastructure vulnerabilities and security gaps are being exploited to secure unauthorized access to proprietary systems and data.

As a preventive measure to enhance data security and ensure cyber-resilience, increased implementation of secure access technologies such as VPNs, two-factor authentication, and other ID and access-management controls for home workers, as well as increased monitoring and threat-detection tools, are being used.

Outsourced service providers are also updating organizational policies (including Bring Your Own Device and work-from-home policies) and data breach protocols in order to reduce security risks. Adequate training of employees about emerging threats and data security issues is also being prioritized by several companies.

Zacks Industry Rank Indicates Encouraging Prospects

The Zacks Outsourcing industry, which is housed within the broader Zacks Business Services sector, currently carries a Zacks Industry Rank #49. This rank places it in the top 19% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all member stocks, indicates continued outperformance in the near-term. Our research shows that the top 50% of Zacks-ranked industries outperform the bottom 50% by a factor of more than two to one.

The buy-side analysts covering the companies in this industry have been increasing their estimates. Over the past year, the industry’s consensus earnings estimate for the current year has increased 5.8%.

Before we present a few stocks that investors can buy or retain given their growth prospects, let’s take a look at the industry’s recent stock market performance and current valuation.

Industry Outperforms Sector and S&P 500

The Zacks Outsourcing industry has outperformed the broader Zacks Business Services sector as well as the Zacks S&P 500 composite over the past year. The industry has gained 2.5% over this period against a 56% decline of the broader sector and 10.9% loss of the Zacks S&P 500 composite.

One-Year Price Performance

Industry's Current Valuation

On the basis of forward 12-month price-to-earnings (P/E), which is commonly used for valuing outsourcing stocks, the industry is currently trading at 22.63X compared with the S&P 500’s 16.19X and the sector’s 22.69X.

Over the past five years, the industry has traded as high as 28.89X, as low as 17.89X, and at the median of 23.48X, as the charts below show.

Forward 12-month Price-to-Earnings (P/E)

3 Outsourcing Stocks to Keep a Close Eye On

We are presenting three stocks that are well-positioned to grow in the near-term. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Automatic Data Processing

This Zacks Rank #2 (Buy) New Jersey-based company provides cloud-based human capital management solutions worldwide. Amid a challenging scenario, Automatic Data Processing remains strong, backed by its momentum in sales, client satisfaction, and client retention.

Higher operating revenues and effective cost-containment measures have helped the company improve its margin performance. The company continues to enjoy a dominant position in the human capital management market through strategic buyouts like Celergo, WorkMarket, Global Cash Card, and The Marcus Buckingham Company. It has a strong business model, high recurring revenues, good margins, and low capital expenditure.

Furthermore, ADP has raised its fiscal 2022 outlook. The company now expects revenues to register 9-10% growth compared with the prior-expected growth rate of 8-9%. Adjusted EPS is now expected to register 15-17% growth compared with the prior expected growth rate of 12-14%.

The company now expects Employer Services revenues to grow at a rate of about 7% compared with the prior-expected growth rate of about 6%. PEO Services revenues are expected to grow at a rate of 14-15% compared with the prior growth rate of 13% to 15%.

The Zacks Consensus Estimate for ADP’s 2022 EPS has moved up 2.2% in the past 90 days. ADP’s shares have rallied 33.5% over the past year.

Price & Consensus: ADP

Paychex

This Zacks Rank #3 (Hold) New York-based provider of integrated human capital management solutions recently declared a dividend hike of 20%, thereby raising its quarterly cash dividend from 66 cents per share to 79 cents. The dividend will be paid out on May 26 to shareholders of record as of May 12, 2022.

Despite the impact of the COVID-19 pandemic, the company continued to enjoy higher revenues per client due to improved price realization, growth in client base across HCM, and ancillary products, resulting from strong sales performance and high levels of retention. This is alongside improved market conditions on asset-based revenues for retirement services and an increase in funding for temporary staffing clients.

An increase in the number of average worksite employees, impact of an increase in average wages per worksite employee, higher revenues on state unemployment insurance, and a rise in PEO health insurance revenues act as other tailwinds.

Acquisitions have expanded Paychex's customer base and generated cost and revenue synergies. Consistency in rewarding shareholders through dividend payments and share repurchases boosts investor confidence and positively impacts earnings per share.

Paychex has raised its guidance for fiscal 2022. Total revenues are now expected to register 12-13% growth compared with the prior expectation of 10-11%. Adjusted earnings per share are now expected to register 22.5-23% growth compared with the prior expectation of 18-20%.

The adjusted operating margin is expected to be almost 40% compared with the prior expectation of 39-40%. The adjusted EBITDA margin is now expected to be nearly 44-45% compared with the prior expectation of 44%.

The Zacks Consensus Estimate for Paychex’s 2022 EPS has improved 3% in the past 60 days. Paychex’s shares have gained 11.5% over the past year.

Price & Consensus: PAYX

Genpact Limited

This Zacks Rank #2 Bermuda-based company provides business process outsourcing and IT services in North and Latin America, India, the rest of Asia, and Europe. Genpact enjoys a competitive position in the BPO services market based on its domain expertise in business analytics and consulting.

Acquisitions have been helping it expand its product portfolio and gain new domain expertise. AI offers ample growth opportunities amid the COVID-19-induced dependency on technology. Consistency in rewarding shareholders through dividend payments and share repurchases boosts investor confidence and positively impacts earnings per share.

For 2022, the company has raised its guidance. Genpact’s guided range for adjusted EPS is $2.60-$2.76 (previous view: $2.53-$2.71). Revenues are anticipated between $4.325 billion and $4.4 billion (prior view: $4.3 billion and $4.4 billion).

The Zacks Consensus Estimate for Genpact’s 2022 EPS has improved 2.3% in the past 90 days. The stock has gained 3% over the past year.

Price & Consensus: G