The Private Investor: 'Temp agencies may hold key to the condition of our economy'

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The Independent Online

Just back from holiday, and found the market has been flying without me. So there is now a desperate need for a good fix on the real economy. Shares are rallying to levels not seen since before 11 September and every chairman's statement seems to have a bullish slant.

Just back from holiday, and found the market has been flying without me. So there is now a desperate need for a good fix on the real economy. Shares are rallying to levels not seen since before 11 September and every chairman's statement seems to have a bullish slant.

But how far ahead of profits is this optimism? Is the market getting as over-bought as it was oversold, or is there scope for it to run? If you turn to official statistics for help, you will find they are dodgy guides even to the past, let alone the future.

Not long ago, sales of copper tubing to the motor manufacturers, house-builders and heavy industries from factories in the Midlands were great as a "straw in the wind" indicator of corporate Britain's real underlying position. Now the factory shop floor is no longer key and the house market is distorted by buy-to-let purchasers and demand from overseas.

With the service industries now dominant, a more accurate test of what is going on is more likely to come from here. In 2003, the substitute for commodity indices or metal markets as a simple barometer of conditions is probably the body count that passes through recruitment companies. Their spread is almost total and they are feeling very optimistic, a reading that bodes well.

The information from companies is good on several levels. Recruiters run two books, temporary and permanent staff, and these days, this applies to professionals as well. The balance between the two is key to a reading of the economy. The more temps are being employed, the more the uncertainty. But if companies become committed to increasing numbers of permanent staff, this indicates not just an increasing workload. The overheads involved in taking on a permanent employee are much higher than a temp, so it is a signal of confidence that demand levels are expected to remain strong for some time.

An old hand at the markets, Jeff Douglas, now at Altium Capital, has come up with a neat measurement, Altium Capital Recruitment indices. These track the market performance of the bunch of recruitment companies. Since March, the main index has been creeping up, and since the beginning of April it has outperformed the FTSE All-Share by 30 per cent. That sounds a lot, but this sector is highly cyclical. Looking back from June over the period since its peak in 1998, shows it has underperformed by 80 per cent. The key to making stock picks in the sector is the amount of net revenue from permanent staff. Here, the conversion rate into gross profits is much higher and the operational gearing on fee income is huge.

Take the main "buy" in the sector, Michael Page, for example. It supplies accounting, marketing and sales staff internationally and is a brand leader and the largest and most liquid stock in the sector. The UK provides more than half its sales. Figures this month showed a better than expected interim pre-tax profit of £11m, leading to an upgrade in forecasts to £21m pre-tax for 2003 with EPS of 3.5p, followed in 2004 by £25.5m with EPS of 5.4p.

To illustrate the operational gearing effect, this forecast is on a quarter by quarter increase in fee income of 5 per cent. Push that to 8 per cent and the pre-tax figure for 2004 rises to £28.8m, and with a 10 per cent rise it goes to £31.5m.

Other picks are Robert Walters, PSD and Spring. Robert Walters gets three-quarters of its business from the UK. It is forecast to make £1m in pre-tax profits this year, with 0.6p of earnings. It is then expected to improve to £1.7m with 1.1p. PSD, with 90 per cent of its business in the UK and permanent staff account for far more than half of its turnover, is expected to make £1.1m pre-tax, with 3p of earnings followed £1.8m with 5p. Spring swings from EPS of 0.4p to 4.5p over the next two years.

City-based Imprint Search is a minnow, but nicely geared in to multinational business. It launched in 2001 but it kept its float promises and announced a profit this week, four trading periods on. It has a rewarding business model and a 35 per cent stake in the company is available as a performance-related reward for staff. It should make £0.35m this year, and is expected to double that next year, with EPS of 2p and 3.8p.

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