Our Picks for a Grim Employment Climate--Page 3

<< Previous Page
1 2 3

What Does It All Mean?
Let me reiterate that we are not forecasting employment. Economic forecasting can be perilous, and no two or three data points should be viewed in isolation. Nearly all measures have at some point falsely pointed to a recession in the past. We're also not trying to predict how the BLS will ultimately adjust the data. We're simply pointing out vulnerabilities in the current data, so that we can be prepared for what the near future might bring. With all of this in mind, we'll now analyze the impact of this environment on our employment-service companies.

Our Stock Picks and Pans in Employment
We've divided our employment companies into those that serve the overall or core employment market and those that serve the temporary staffing and permanent placement markets, or noncore employment. The primary reason for this differentiation is that it helps to separate high-quality stocks from low-quality ones, and the risky from the stable. This is not to say that there aren't good companies in noncore employment, but they're less common, generally less profitable, and more difficult to value. As demonstrated in a chart on Page 1, the temporary staffing market is much more volatile than overall employment. In fact, as shown in the chart below, employment growth has ranged between negative 3% and positive 6% during the last 60 years, compared with temporary staffing's negative 18% and positive 19% during the last 18 years.

Two of our favorites are ADP (ADP) and  Paychex (PAYX). Both are wide-moat, below-average-risk, 5-star stocks--characteristics that describe less than 2% of our coverage universe. Even though falling employment associated with a potential recession is certainly a short-term risk, if history is any indication, the fallout won't be back-breaking for these firms. Long-term population and employment growth, a large untapped market, and cross-selling potential provide strong tail winds. Another reason these companies have become cheap during the last few months is falling interest rates. Both ADP and Paychex benefit from float income on funds held for clients as the cash passes from employer to employee. Because of their conservatism, these funds are held in safe, highly rated investments that generally reflect current short-term interest rates. When the Fed lowers rates by 75 basis points, float income suffers. However, we've captured this in our model and would not flinch if rates went even lower. We wouldn't be surprised to see these stocks react negatively if employment does take a sharp turn for the worse, but we're comfortable with these recommendations for the long run.

There are several other solid employment firms out there.  Administaff  and Gevity  also operate in the core employment market but with a risky twist. Both firms are professional employer organizations, leaving them vulnerable to insurance claims because of their coemployment relationship with clients. Under this model, revenue is reasonably stable but profitability is more variable, as you might expect. In addition, Gevity adds the unfortunate twist of management and strategy turmoil. Therefore, while its target markets have been stable, Gevity has been volatile, leading to our above-average risk rating.  AMN Healthcare (AHS) also looks cheap. Although it operates in the temporary staffing market, it benefits from the relatively stable demand for health-care professionals.  Robert Half (RHI),  Manpower (MAN), and  Trueblue (TBI), though not cheap enough to buy today, are excellent companies that have developed good brands and solid returns.

The remaining companies in the list below have not been able to rise above the competitive pressures of the employment industry. The reasons include a weak brand, ill-advised acquisitions with cash earned in peak years, weak bargaining position with large clients, or concentrated exposure to an especially cyclical customer base. Most of the companies on this list are outliers in terms of revenue and profit volatility, and on average are unable to earn their cost of capital through an economic cycle. As such, we're hesitant to purchase their shares in most situations. Looking at the one-year performance data in the chart below, it's interesting to note that even though many prognosticators are hanging their hopes on strong employment, investors in these companies certainly haven't been.

Core Employment
Company	Industry	Moat	Risk Rating	Star Rating	P/FV	1-Year Perf.
ADP (ADP)	Payroll	Wide	Below Average	5	0.74	-5%
Administaff	PEO	Narrow	Average	5	0.66	-29%
Gevity	PEO	Narrow	Above Average	5	0.48	-68%
Paychex (PAYX)	Payroll	Wide	Below Average	5	0.72	-14%
Non-Core Employment
Company	Industry	Moat	Risk Rating	Star Rating	P/FV	1-Year Perf.
AMN Healthcare (AHS)	Staffing	Narrow	Average	5	0.71	-40%
Hudson Highland Group (HHGP)	Staffing	None	Above Average	3	1.08	-58%
Kelly Services (KELYA)	Staffing	None	Above Average	3	0.83	-40%
Kforce (KFRC)	Staffing	None	Above Average	3	0.86	-39%
Manpower (MAN)	Staffing	Narrow	Average	4	0.85	-34%
MPS Group	Staffing	None	Above Average	3	0.95	-31%
Robert Half (RHI)	Staffing	Narrow	Average	4	0.88	-41%
Spherion	Staffing	None	Above Average	3	0.94	-15%
Trueblue (TBI)	Staffing	Narrow	Average	3	0.95	-32%
Volt Information Sciences (VOL)	Staffing	None	Above Average	3	1.03	-50%

We plan to write an employment update quarterly going forward. As public employment companies report annual earnings and give 2008 expectations during the next couple of months, we'll probably have a good sense of where the labor market is heading, as the information they can provide on a multitude of industries and markets is invaluable. We'll also check in with the BLS numbers once again to see how the labor market on the whole is faring.