How to Invest in a Jobs Recovery

 | Dec 23, 2011 | 10:21 AM EST  | Comments
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Stock quotes in this article:

ctas

,

gksr

,

adp

It feels odd to present a stock idea based on a domestic jobs recovery when we hear daily accounts of baby boomers burning through their retirement savings due to job loss, underemployed college grads barely meeting their student loan obligations, and politicians spewing the boilerplate line, "We must create jobs in America." And let's not forget the economists who have fallen in love with the term "muddle through" when describing economic output potential in 2012. It feels as if we never exited the Great Recession. I can't tell you how many empty storefronts and boarded up homes I see in any given week.

Yet, the weekly macro data suggests something positive has begun to happen in the jobs market, and investors have to accept it or risk buying associated stocks 20% higher than present levels. For a good part of December, I sensed heightened anticipation for jobless claims data. Why? The numbers are finally starting to improve and come in below expectations. Marry this with favorable readings on the ISM employment components, and suddenly we have a December nonfarm payrolls report that could print 200,000 on the headline.

If you haven't had a brainstorm on how to invest alongside a domestic jobs recovery, no sweat; I'm here to help. Let's get creative, and get our hands dirty, in the selection process. (Though I don't want to be the guy who says chase ADP (ADP) at a 52-week high because it processes corporate payrolls. We can do better than that.)

Uniform rental company Cintas (CTAS) had a strong earnings report this week, headlined by a $0.09 per share upside and a full-year guidance raise. Chances are you never realized that the company even reported (the market sure did; the stock was aggressively bid higher), which is fine; it's impossible to know every single story in the market. As long as you're aware of the general reasons why Cintas had a solid quarter (more companies using its services), you're ready to find derivative investments -- especially important given rising jobs bullishness on the Street.

To that end, there's G&K Services (GKSR). Founded in 1902, it has a similar business to Cintas except it's primarily a U.S. business with modest operations in Canada. I was drawn to G&K because it's the smallest publicly traded uniform rental company in a fragmented industry that's known for consolidation. That, along with the fact G&K Services owns 90% of its processing facilities and has been paying down debt (debt-to-equity ratio is sufficiently under 25%), I have to imagine a remote possibility that the company is swallowed up in the future (maybe by Cintas).

Nonetheless, this is not a call based on wishful thinking: The valuation is misaligned in the context of the fundamentals. Wall Street has gotten itself in a tizzy that management has decided to invest more money in uniform inventory, somewhat hampering free cash flow. Hogwash. The company is investing in its business while still supporting an impressive 30% dividend-payout ratio (2% yield) because it's winning new accounts and retaining its client base. Importantly, G&K Services is not sacrificing its pricing model to achieve these results. I am able to decipher this because the company raised its fiscal-year earnings guidance in November, despite keeping its revenue guidance intact.

Assuming my read on the jobs market is correct, and G&K Services continues to benefit from lower merchandise and energy costs, upside earnings should be the result. The stock deserves a multiple closer to 15x (currently 13x, a 31% discount to the nine-year mean) and a forward-earnings estimate of $2.30 (currently $2.27), which projects upside potential of roughly 19%.

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