7 Stocks With Improving Profit Margins

During your next frantic phone call to check whether your bank is still in business, consider investing in a company that might be fielding the call. Tampa-based Sykes Enterprises (SYKE) provides call-center services in more than a dozen countries, and seems to be holding up nicely amid global investor angst. Profits are on pace to jump 43% this year. Shares are moving in the right direction and still look cheap.

Sykes phone reps handle credit card and bank account inquiries, computer and electronics support, roadside assistance calls and even calls from health-plan members wondering whether a new rash warrants a trip to the doctor. Callers from the U.S. might get a rep in the Philippines and ones from Spain might be handled in El Salvador, but many of the company's call centers are located in or near the countries they serve, including the U.S., Canada, Italy, China and much of Scandinavia.

The cell-center business as a whole seems worthy of investment. Last year it brought in sales of $38 billion. Industry forecasters expect that figure to grow to $50 billion by 2012. Just 20% of customer calls are currently outsourced. Specialists like Sykes can typically run call divisions more cheaply than companies can on their own.

Sykes isn't nearly the only company in its business, of course, but it might offer the most appeal to investors. Giant companies like IBM (IBM) and Accenture (ACN) have call center divisions, but mostly engage in other businesses like information-technology consulting. Among pure-play companies, Sykes seems more secure than its competitors. Its top five customers together contribute less than a quarter of sales, compared with at least 40% for peers, according to Ladenburg Thalmann, a New York investment bank. That reduces the risk of a big customer going out of business. Also, Sykes is growing faster than the industry, suggesting it's taking share. Sales are expected to increase 17% this year.

Sykes shares are up 6% since I last recommended them two years ago, compared with a 16% decline for the broad market. They've doubled in price since my first recommendation just over three years ago. But sales and profits have grown much faster than the stock price during that time, so Sykes looks like a better deal today. At the time of my first and second recommendations of the stock it went for 28 and 22 times earnings, respectively. Now it sells for less than 15 times the 2008 forecast.

The present state of the credit market calls for careful attention to companies' financial resources. Sykes seems well stocked on buying power. It is debt-free and holds almost too much cash: $5 a share, or about a quarter of the company's market value. Don't expect a one-time dividend or share repurchase. Most of that cash is held overseas, and so would be taxed heavily if brought back. But Sykes' future expansion is at least not dependent on it securing financing. That leaves as the primary risks facing the company a sharp slowing of customer call volume or a rekindled interest in in-house call centers. The stock's price seems more than discounted for the likelihood of either event.

Sykes turned up recently on a search for companies with improving profit margins. It is expected to turn 7.7 cents of each sales dollar into operating profit this year, rising to 8.1 cents next year. Those numbers aren't especially impressive. The median S&P 500 company clears 10 cents on the dollar as operating profit. But Sykes' numbers are getting better fast as it makes fuller use of its call-center capacity. In 2005 operating profit was just 5.3 cents of each sales dollar.

Have a look if you like at six other companies the profitability search produced, or create a fresh list using SmartMoney's stock screener and the full list of criteria.

Profitability Screen Recipe
Net margin increase vs. five-year average in top 25% for industry
Operating margin increase vs. five-year average in top 25% for industry
Current-year EPS estimate raised within past four weeks
At least three analysts in earnings consensus
Debt/total-capital below 0.5
Average analyst recommendation "buy" or "strong buy"
Trailing 12-month sales greater than $300 million
Average daily trading volume greater than 200,000 shares