Four Top HR Outsourcing Stocks

Human resources used to be an afterthought to business leaders. Executives would relegate HR work to "back-office" status because they were more concerned with initiatives that increased the top line, so-called "front-office" work. However, as managers become aware of the savings that efficient HR systems can provide, interest in outsourcing has risen. First, let's consider what motivates companies to outsource, then look at a few of our favorite stocks in this industry.

Many firms use antiquated systems that were installed years (or even decades) ago that, although cutting-edge at the time, are now a precarious patchwork of short-term fixes. This is especially true of large corporations that have grown through mergers and acquisitions without upgrading the infrastructure that supports its employees, as each entity usually operates its own proprietary system.

What's the solution? One option is to update current systems with new software and streamlined procedures. Although this seems simple enough, researching the appropriate upgrade is time-consuming, and up-front investments can be prohibitive. Meanwhile, the savings are far from guaranteed. In fact, once the digging starts, it's common for firms to find that the HR situation is more dire than expected. Fortunately for the outsourcing firms discussed below, these unforeseen issues, along with the more-obvious deficiencies that companies endure, bolster the value proposition of outsourcing.

What's the solution? Let someone else worry about it! This is a rare situation in which the easier solution might also be the best long-term strategy. Outsourcing firms have changed HR functions from a necessary evil into an expertise by claiming "back-office" functions as a core competency. Therefore, outsourcing firms are generally capable of providing the most efficient services at the lowest cost. Also, continuous business improvement is crucial for an outsourcing firm to maintain its competitive edge, and this prevents obsolescence. Now instead of needing to undergo massive upgrades every few years, companies using reliable outsourcing firms can rest assured that they are benefiting from best practices in HR.

One caveat though--the one-stop-shop HR outsourcing model has struggled. Often termed human resource business process outsourcing, this new offering focuses on large corporations--usually with more than 10,000 employees--and handles nearly every HR function. Although it has great potential to cut costs for clients, the benefits are much less evident for the service provider. Therefore, most outsourcing companies, such as  Automatic Data Processing (ADP),  IBM (IBM), and  Accenture (ACN) are treading lightly with this comprehensive solution until the proper business model is found.

Here are a few of our favorite HR outsourcing companies along with explanations of why they are successful.

 Paychex (PAYX)
Paychex provides outsourcing for several HR functions, but its primary business is payroll processing. Through a well-developed technological and operating infrastructure, Paychex eliminates the complexity and risk that come with managing payroll internally. In addition, clients avoid the large capital investments that are necessary to build this transaction-intensive ability. Meanwhile, Paychex is immensely profitable due to the scale it achieves by aggregating client payrolls. With a 5-star Morningstar Rating for stocks, we see the present stock price as a good buying opportunity.

 AMN Healthcare (AHS)
AMN is the largest health-care staffing firm in the U.S., and this gives it a significant advantage over small regional firms because of the increased assignment variety it can offer--a crucial draw for applicants. This advantage is important to clients because there is a shortage of health-care workers, and it's expected to get worse. In addition, AMN's national recruitment network is proficient at moving workers around the country to fill client needs--something a local hospital would have great difficulty duplicating. A recent runup in the firm's stock price leaves the company near our estimate of its fair value, but if it were to pull back, we'd jump in with both feet.

 Administaff 
Administaff is a professional employer organization that operates under the co-employment model--a highly integrated form of HR outsourcing. In this structure, Administaff handles nearly all HR functions. However, unlike HR business process outsourcing providers, Administaff focuses on small businesses--firms that generally have fewer than 20 employees--and this greatly simplifies its business model. One way in which the firm adds value is by pooling all of its client employees into a much stronger bargaining group, which allows Administaff to negotiate for lower health insurance and workers' compensation premiums. After surpassing our "consider selling" price just a few months ago, this stock has pulled back sharply and now trades near our 5-star price.

 Hewitt 
Hewitt's position as both a consulting and outsourcing firm creates valuable synergies. With the information accumulated from its benefits outsourcing experience, Hewitt consults for firms that need help with benefit programs but aren't willing to take the outsourcing leap. Through its 60-year history, Hewitt has gained expertise that keeps more than 90% of its clients coming back every year.

Recently, Hewitt's stock has been hurt by troubles in its HR business process outsourcing service. Unfortunately, Hewitt swam too deep before the waters in this complicated business had been tested. Still, Hewitt's non-HR business process outsourcing operations (80% of revenue) continue to perform and generate more than enough value to support our opinion that Hewitt's stock is cheap.