Business services providers play a critical role for enterprises, assisting them with everything from new hardware integrations to consulting and marketing. Still, investors are uneasy as firms face challenges from AI-driven disruptors and tightening corporate budgets. These doubts have caused the industry to lag recently as services stocks have collectively shed 3.1% over the past six months. This performance was discouraging since the S&P 500 held steady.

Investors should tread carefully as many of these companies are also cyclical, and any misstep can have you catching a falling knife. With that said, here are three services stocks we’re swiping left on.

Telephone and Data Systems (TDS)

Market Cap: $3.90 billion

Operating primarily through its majority-owned subsidiary UScellular and wholly-owned TDS Telecom, Telephone and Data Systems (NYSE: TDS) provides wireless, broadband, video, and voice communications services to 4.6 million wireless and 1.2 million broadband customers across the United States.

Why Are We Out on TDS?

1. Products and services are facing significant end-market challenges during this cycle as sales have declined by 1.6% annually over the last five years
2. Earnings per share have contracted by 24% annually over the last five years, a headwind for returns as stock prices often echo long-term EPS performance
3. High net-debt-to-EBITDA ratio of 26× could force the company to raise capital at unfavorable terms if market conditions deteriorate

Telephone and Data Systems is trading at $34.01 per share, or 3x forward EV-to-EBITDA. Dive into our free research report to see why there are better opportunities than TDS.

DXC (DXC)

Market Cap: $3.00 billion

Born from the 2017 merger of Computer Sciences Corporation and HP Enterprise's services business, DXC Technology (NYSE: DXC) is a global IT services company that helps businesses transform their technology infrastructure, applications, and operations.

Why Do We Think DXC Will Underperform?

1. Organic revenue growth fell short of our benchmarks over the past two years and implies it may need to improve its products, pricing, or go-to-market strategy
2. Falling earnings per share over the last five years has some investors worried as stock prices ultimately follow EPS over the long term
3. ROIC of 1.3% reflects management’s challenges in identifying attractive investment opportunities, and its decreasing returns suggest its historical profit centers are aging

At $14.23 per share, DXC trades at 4.9x forward P/E. Check out our free in-depth research report to learn more about why DXC doesn’t pass our bar.

Exponent (EXPO)

Market Cap: $3.95 billion

With a team of over 800 consultants holding advanced degrees in 90+ technical disciplines, Exponent (NASDAQ: EXPO) is a science and engineering consulting firm that investigates complex problems and provides expert analysis for clients across various industries.

Why Do We Steer Clear of EXPO?

1. Muted 4.5% annual revenue growth over the last two years shows its demand lagged behind its business services peers
2. Modest revenue base of $518.7 million gives it less fixed cost leverage and fewer distribution channels than larger companies
3. Diminishing returns on capital suggest its earlier profit pools are drying up

Exponent’s stock price of $77.74 implies a valuation ratio of 37.1x forward P/E. To fully understand why you should be careful with EXPO, check out our full research report (it’s free).

Stocks We Like More

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