As jobs bloom, so do employment-services stocks

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With Canada's economy chugging ahead, and more than a million jobs added in the U.S. so far this year, this should be the happiest Labour Day in some time.

The shares of the companies in the employment-services sector have already been celebrating. Several of the most famous names in payroll processing, hiring and recruiting are now robustly valued – to the point where further gains may be limited.

However, there are still a few companies that may offer opportunities to discerning investors. And with our help, you don't have to labour to identify them.

Let's start by examining some of the names heard most often when the discussion turns to companies that benefit when businesses resume hiring workers.

Automatic Data Processing Inc. and Paychex Inc., the leading North American providers of payroll services, have each recently hit 52-week highs. Each is now trading at elevated levels, changing hands for more than 22 times projected profits for the next year.

ADP is among the bluest of blue chips, with a triple-A credit rating from Standard & Poor's. Paychex, with no debt and more than $500-million in cash, looks weak only in comparison to ADP. Both pay dividends, yielding 2.4 per cent and 3.6 per cent, respectively.

But their valuations cause the analysts who follow them to stop short. Fewer than half of those following ADP have "buy" recommendations, according to Bloomberg data. The split on Paychex is even more pronounced: two "buys" and 21 "holds" out of 27 recommendations.

Analysts are also mixed on some of the recognizable names in hiring and recruiting: industry giant ManpowerGroup Inc., executive recruiter Korn/Ferry International, and temp agency Kelly Services Inc.

Each, however, has its fans. Analyst Andrew Steinerman of J.P. Morgan is impressed with ManpowerGroup's ability to drive recent earnings with cost cutting in the face of revenue declines, particularly from its massive European business.

It is, Mr. Steinerman says, "a generational shift of efficiencies" at the company, which says it has created a new, permanently lower cost structure that will allow for better profitability in slow times.

Investors have noticed, sending the shares up nearly 75 per cent over the past 52 weeks. That, and the company's P/E of 16, a bit on the high side for a company with declining sales, has scared off a number of analysts. But Mr. Steinerman maintains an "overweight" rating and a $72 (U.S.) price target on the shares.

Michael Jaffe of S&P CapitalIQ rates Kelly Services Inc. a "strong buy" with a $28 price target, versus current trades around $18. Trading at a little over 13 times the next 12 months' earnings, it has one of the lowest multiples in the sector.

Tobey Summer of SunTrust Robinson Humphrey has a "buy" on recruiter/consulting company Korn/Ferry, with a $24 target price (versus recent $18 trades.) The company has $3.25 per share in cash and is slowly increasing its profit margins, Mr. Summer says. At less than 14 times forward earnings, it is below its long-term average multiple, he notes.

The recruiting company that generates the most enthusiasm among analysts, however, is Robert Half International Inc., with 10 "buy" calls versus just three "holds."

Sun-Il (Sean) Kim of RBC Dominion Securities' U.S. arm says he favours the company because of its higher exposure to the United States and its concentration on professional-level jobs in technology and finance. He has an "outperform" rating and $40 price target.

In a mid-year report, J.P. Morgan's Mr. Steinerman called Robert Half his "best idea" for the second half of 2013 among the business and information-services companies he covers in a mid-year report.

He called it the "King Kong of accounting staffing," with 20-per-cent market share, and said it "should benefit from much faster growth and higher profitability than most staffing companies" through this economic cycle.

Mr. Summer, of SunTrust Robinson Humphrey, reserves his greatest enthusiasm for firms that may be less recognizable than these big names.

One, his top pick, is Towers Watson & Co., the combination of the firms formerly known as Towers Perrin and Watson Wyatt. The company's core business is consulting on pension and health care benefits, but it's been expanding into investment and human resources consulting.

What's exciting investors – and Mr. Summer – is Towers Watson's recent acquisition of the U.S.'s largest privately owned health insurance exchange. (The exchanges are where individual health-insurance policies will be sold under the rules of the Affordable Health Care Act, or Obamacare.)

"It's only a very, very small part of the business – 3 per cent of revenue – but it's considered by us and the market to be very, very promising," he says. "We think it has the potential to transform the overall business." (He has a $110 target price, versus recent trades around $84.)

Two of Mr. Summer's other favourites are lesser-known niche players in hiring and recruiting, On Assignment Inc. and AMN Healthcare Services.

On Assignment, which Mr. Summer says is "the fastest-growing and highest-margin business in staffing," gets three-quarters of its business from the tech industry. Mr. Summer says the company focused on high-end jobs before acquiring a more mainstream staffing business over a year ago.

"The combination has proven very powerful. They can go to customers and say, 'Listen, what's the one job you haven't been able to fill for the last year?' They can have the high-end staffing company fill that job, and then the mainstream staffing company gets a bigger portion of the customer's wallet."

Investors have noticed, sending the shares up 88 per cent in the past 52 weeks and giving the company a larger market capitalization than Korn/Ferry and Kelly Services combined. But with more room for revenue growth and margin expansion, there's more room for the stock to go up, Mr. Summer believes. (His target price is $37, versus recent trades around $31.)

Mr. Summer says AMN Healthcare Services specializes in both temporary and permanent placements for nurses, physicians, and other healthcare workers.

"Hospitals, more and more, are signing up with one staffing company in what's called a managed-service provider relationship, where a staffing company takes responsibility for all the clinical staffing for that customer," he says. "AMN Healthcare Services is the largest at it and has a scale advantage already." His price target is $19, versus recent trades around $14.

It seems investors still have ways to profit as folks go back to work.