3 IT Services Stocks to Buy From a Challenging Industry – Zacks.com

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Aniruddha Ganguly

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The coronavirus pandemic-triggered macroeconomic downturn has induced sluggishness in IT spending, impacting the adoption of consultation and transaction processing solutions. Consequently, the outlook for the Zacks Computers – IT Services industry appears drab at the moment.

However, the ongoing digitization and initiatives to diversify IT services have somewhat improved the prospects for the industry players. ServiceNow (NOW Free Report) , EPAM Systems (EPAM Free Report) and CDW Corporation (CDW Free Report) are some of the stocks benefiting from this trend. Moreover, solid demand for advanced IT-service infrastructure solutions for remote working and digital healthcare has been a boon for these IT Service providers.

The Zacks Computers – IT Services industry comprises companies that provide consultancy, communications, IT management & operations, cloud-based web development platform, customer relationship management, professional information solutions and outsourcing services. The industry participants cater to a wide array of end markets, including manufacturing, banking, insurance, healthcare, government agencies and public sector institutions. Industry participants like DXC Technology (DXC Free Report) focus on cyber business, cloud computing market and Big Data business to bolster prospects. Digital transformation is helping companies like CDW and ServiceNow to gain market share.

Sluggish IT Spending to Mar Prospects: Coronavirus crisis-induced sluggish spending across small and medium businesses (SMBs) due to restricted economic activity globally has impacted the adoption of IT-services, primarily consulting services applications, infrastructure management, and transaction processing platforms. The industry players are anticipated to bear the brunt of the slowdown in IT spending. Additionally, the shift in consumer buying patterns amid coronavirus-induced supply chain constraints are likely to dampen the industry’s prospects. The COVID-19 pandemic led softness in the travel and hospitality end-markets remains a concern. Also, the shift from enterprise to consumer-focused demand, due to the continued work-from-home trend, does not bode well for industry players.

Digitization Wave is a Tailwind: Most of the industry participants are in the process of modernizing their traditional legacy-oriented business processes in order to keep pace with evolving IT services. The aim is to integrate synergies of emerging technologies including cloud, IoT, AI and analytics. Moreover, increasing Internet penetration in the emerging markets, particularly across Asia-Pacific, is a tailwind. For instance, DXC is focusing on cyber business, cloud computing market and Big Data business to bolster prospects. Moreover, CDW is gaining from growth across all the end markets with strength in small business, government and healthcare verticals.

New Normal Trends Boost Prospects: The industry’s growth is expected to accelerate in the days ahead on increasing number of remote workers in the wake of the coronavirus crisis-induced work-from-home wave. In this era of digital transformation, enterprises are actively seeking a common ground between on-premises and cloud infrastructures that will enable them to provide flexible and easily adoptable hybrid solutions. Notably, coronavirus-triggered demand for remote working, digital healthcare and online learning solutions has accelerated the adoption of digital transformation offerings among enterprises, which bodes well for the industry.

The Zacks Computers – IT Services is housed within the broader Zacks Computer And Technology Sector. It carries a Zacks Industry Rank #205, which places it in the bottom 18% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is the average of the Zacks Rank of all the member stocks, indicates bearish near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic on this group’s earnings growth potential. Since Nov 30, 2020, the industry’s earnings estimate for the current year has declined 7.2%.

Despite the gloomy industry outlook, a few stocks have the potential to outperform the market based on a strong earnings outlook. But before we present the top industry picks, it is worth taking a look at the industry’s shareholder returns and current valuation first.

The Zacks Computers – IT Services Industry has underperformed the Zacks S&P 500 composite sector but lagged the broader Zacks Computer and Technology in the past year.

The industry has returned 40.1% over this period compared with the S&P 500 and the broader sector’s rally of 41.2% and 35.1%, respectively.

On the basis of the trailing 12-month EV/EBITDA ratio, which is a commonly used multiple for valuing IT Services companies, the industry is currently trading at 37.87X, higher than the S&P 500’s 15.93X and the sector’s 16.10X.

Over the past five years, the industry has traded as high as 38.96X and as low as 18.98X, with the median being at 27.34X, as the chart below show.

EPAM Systems: The Newton, PA-based company provides software engineering and IT consulting services. EPAM is benefiting from ongoing digital transformation and continued focus on improving customer engagement and product development. The strong performance of Business Information & Media, the company’s largest industry vertical, is driving its top line. The company is benefiting from growth across all geographies and multiple industry verticals. The latest forecast for worldwide IT spending by Gartner is a positive for EPAM. The worldwide IT spending is anticipated to be $4.2 trillion in 2021, suggesting an increase of 8.6% from 2021. The research firm expects worldwide spending on IT services to grow 9% year over year to $1.11 trillion this year.

EPAM currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The Zacks Consensus Estimate for its fiscal 2021 earnings has risen 13.6% to $8.40 per share over the past 60 days. The stock has appreciated 75.9% in the past year.

CDW Corporation: This Vernon Hills, IL-based company benefits from the ongoing digital transformation and increased demand for products that enable remote working and operations continuity plans amid the COVID-19 pandemic. It is also gaining from growth in education and healthcare end markets.

Moreover, the acquisitions of Scalar Decisions and Aptris have strengthened its capabilities and expanded its product offerings. Progress in network management, storage management and operating system software is a tailwind. CDW’s core strength of providing best-in-class services and easy-to-acquire technologies will bolster growth over the long haul.

The Zacks Consensus Estimate for this Zacks Rank #2 (Buy) company’s 2021 earnings has been revised upward by 4.6% over the past 60 days to $7.70 per share. The stock has gained 55.7% in the past year.

ServiceNow: This Zacks Rank #2 provides cloud computing services that automate digital workflows to accelerate enterprise IT operations. The company’s Now Platform enables enterprises to enhance productivity by streamlining system processes.

ServiceNow is benefiting from robust growth in subscription revenues driven by the digital transformation of enterprises. As enterprises continues their transition to cloud, the company is poised to boost uptake of its Now platform. Its workflow solutions have been winning customers regularly. Further, ServiceNow’s expanding global presence, solid partner base and strategic buyouts are expected to bolster growth prospects. Also, strategic alliances with the likes of Microsoft are tailwinds.

The Zacks Consensus Estimate for this Santa Clara, CA-based company’s 2021 bottom line has been revised up 1.4% to $5.80 over the past 60 days. Shares of the company have risen 26.3% in the past year.

ServiceNow, Inc. (NOW) – free report >>
EPAM Systems, Inc. (EPAM) – free report >>
CDW Corporation (CDW) – free report >>
DXC Technology Company. (DXC) – free report >>
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