As the industrial revolution was the lifeblood of the United States economy early on, the service sector is the heartbeat of the economy today. According to The Atlantic, in 2017 services represented 67% of the gross domestic product (GDP) in the United States.
With services accounting for so much of America’s economic activity, it only makes sense that there are massive, profitable companies in the sector. Of course, these companies have generated tremendous profits for stock market participants, who have piled their money into the space.
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On the other hand, just like any other sector, the service sector has its winners and losers, profitable companies and those that operate at a loss, and market caps ranging from micro to blue chip. Making an investment in a stock just because it’s in the service sector, with no research or any other form of due diligence, is nothing more than gambling. It’s important that you understand just what you’re investing in and the prospect for growth the investment offers.
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What Are Service Stocks?
Service stocks are stocks that represent companies within the service sector. So, when you purchase a service stock, you’re purchasing a small portion of a company that works within the service sector.
The service sector is vast, covering any company that provides a service to its customers. Some of the most common examples of service companies include:
- Technology. Technology is one of the biggest subsets of the service industry. This is the subsector in which e-commerce, web and database hosting, artificial intelligence, cloud computing, and other technology based services live.
- Medical. Medical services is a subset of the service sector that centers around delivery of health care. Hospitals, at-home medical services, nursing homes, and other similar services are found within this category.
- Utility. Utility services are another massive subset of the service sector. These companies provide the basic utilities that most people simply couldn’t live without. They provide electricity, water and wastewater, garbage pickup, and other simple necessities to consumers.
- Financial. Financial services encompass a wide range of services revolving around money. These include banks, investment brokers, hedge funds, budgeting applications, and any other service that involves the management or movement of money.
- Media. Media is also a cornerstone within the service industry. News companies, social media companies, and entertainment companies all fall within this category. One of the largest members of the media category is Disney, which owns ABC, ESPN, and other major TV networks in addition to many popular film franchises.
- Transportation. Finally, transportation services are another major category within the service sector. Airlines, bus lines, taxis, and peer-to-peer rideshare programs are all included in the transportation subset of the service industry.
- Consumer Discretionary Services. Consumer discretionary services are not essential to day-to-day life, but they’re desirable if there’s enough income to cover them. For example, cable services, piano lessons, and gym memberships all fall into the consumer discretionary services category.
A Post-Coronavirus Resurgence in Service Stocks Is on the Horizon
COVID-19 has had an unprecedented impact on the U.S. economy and likely will for quite some time. For service stocks, the pandemic has been a mixed bag of good and bad news.
Services that improve the stay-at-home way of life and promote financial wellness have done very well. For example, utilities that keep you cool in the summer and cloud computing service providers that keep the websites you shop on running are doing great. Fast food restaurants like McDonald’s have done well, as have companies in the media space as both drive-thrus and news outlets are becoming consumer staples.
However, not all service stocks have fared well during the COVID-19 pandemic. With shelter-in-place orders, the travel and transportation industry has suffered in a big way. During a pandemic in which a deadly virus is spreading uncontrollably, people don’t want to travel. As a result, cruise lines, airlines, taxi companies, and other businesses that focus on moving consumers from one place to another have dealt with some serious pain. Brick-and-mortar retailers have also been dealt a tough hand, along with casinos and other businesses considered to be nonessential.
There is a strong argument that this pain will soon end and, when it does, these companies will see growth like never before. With COVID-19 vaccines already being distributed in the United States and around the world, this argument has become hard to ignore.
At the same time, there has been quite a bit of promising news on the treatment side of the equation.
As treatments and vaccines become available, people will become more comfortable when it comes to travel. Some people have been cooped up in their homes for months, and not leaving for work, shopping, or visits with family will take its toll. So, as soon as it becomes safe to travel, the floodgates will likely open in the industry.
This will lead to a massive increase in demand for travel and other consumer discretionary services, which will equate to higher prices, higher revenues, and higher profits in what some argue will be the biggest sector-wide bull run since the dot-com era.
Service Stock Pros and Cons
No matter what sector you’re looking into, there will always be pros and cons to consider. The service sector is no different. Here are the main benefits and drawbacks that you’ll experience when you invest in service stocks.
Service Stock Pros
With the service sector making up the lion’s share of United State GDP, there are plenty of benefits to investing in these stocks. Some of of the most important include:
1. The Cool Factor
Not all service stocks would be considered “cool” by the average investor; there’s really nothing cool about a taxi service. However, there are areas of the service sector that do have the cool factor. Many people find the technology that keeps the websites they shop on alive to be incredibly interesting. The inner workings of the media also can be an exciting topic. Some of the top stocks in the service sector fall into the category of “cool.”
There’s an often-unseen benefit to investing in what’s cool — the fact that the average person will be more willing to do the research when investing in something they view as cool and interesting than when investing in something they view as dull.
That’s a huge strategic benefit.
Educated investments make the best investments. Those who educate themselves prior to investing in the stock market have a much higher likelihood of generating profits from their investments. When something is cool enough to keep you interested, the sky’s the limit in terms of research you can do to understand a company that delivers an exciting or important service.
2. Stable Growth and Dividends
The service sector is massive, and not all stocks within the sector are created equal. However, there is one subset of the service sector that’s known for stable growth and strong dividends. That’s the utilities services subsector.
Utilities companies provide the very basic necessities that consumers need in order to be comfortable, making them consumer staple services. Heating and cooling, water, and waste services are all basic parts of life that most take for granted. But they are all big business. Moreover, these are largely recession-proof companies.
Even in the face of tough economic times, you’re going to pay your electricity bill, keep your water running, and make sure that your trash is picked up on time. This provides a sense of stability within your investment in utilities, with utility companies growing slowly but offering relatively steady gains over time.
Also, due to the highly predictable nature of the utilities service industry, these companies are known for paying strong dividends. It’s more common to see dividend yields above 3% in the utilities services space than below.
3. Diversified Investment Options
Most experts will tell you that you need to diversify your portfolio. Diversification offers a sense of protection, helping to offset losses when you make a bad investment move, ensuring that you don’t take a significant hit.
Because the service sector as a whole is a heavily diversified one, ranging from consumer services stocks to business services, it’s easy for investors to get a strong understanding of the sector and maintain a heavily diversified portfolio, all by investing in this single space.
While every sector has its share of small-, medium-, and large-cap companies, trading with a wide range of valuations, the service sector is the only one in which you find both cyclical and noncyclical stocks. It’s also the only sector that includes multiple, diverse other sectors, including technology companies, health care services, retailers, and utilities services.
The unique diversification opportunities brought to the table are unmatched by any other sector. There’s a high level of value in that fact.
4. The Feel-Good Factor
Finally, there’s one area of the service sector where an investment can not only turn into profits, but it can make you feel good as well. That’s the medical services subset of the service sector. When you invest in medical services, you’re investing in the unsung heroes who will spend their lives saving the lives of others.
Not only is medicine a profitable industry that offers up a strong investment opportunity, but, when you invest in the space, you can go to sleep at night knowing that your activity in the stock market is funding the companies that keep your community healthy and provide comfort and care to the sick.
Pro tip: If you’re going to add service stocks to your portfolio, make sure you choose the best possible companies. Stock screeners can help you narrow down the choices to companies that meet your requirements. Learn more about our favorite stock screeners.
Service Stock Cons
Service stocks can be great investment vehicles for several reasons, but they do come with their downsides. No sector is perfect, not even the service sector. Some of the drawbacks to consider when investing in the sector include:
1. Services Evolve
The fact that services evolve is a major danger when investing in service stocks. For example, cable companies were once the darlings of the service sector, becoming a consumer staple in the United States. The vast majority of homes in America were connected to the cable grid or receiving television via satellite.
That’s no longer the case.
Streaming services like Netflix and Hulu have given rise to a growing wave of cord cutters in the U.S. and around the world. People are starting to realize that streaming services are far less expensive, and they are switching to save money. As a result, cable companies now fall in the consumer discretionary category as a vast audience is now looking to other options.
The same type of evolution is starting to take place in the taxi service. Once the best way to get around when you didn’t own a car, taxis made plenty of money. Now, companies like Uber and Lyft are taking over by offering low-cost peer-to-peer alternatives to traditional taxi services.
Although a service you invest in may be in high demand today, a simple twist on that service tomorrow could lead to dramatic declines in your portfolio. So, when investing in the service space, it’s important to stay ahead of consumer trends.
2. The Sector Is So Big It’s Hard to Navigate
The service sector is massive, covering a wide range of industries, each with their own set of moving parts. In some ways, saying that you’re investing in service stocks is nearly as vague as saying that you’re investing the stock market in general.
Considering this, there are so many options in the sector that the sector itself can be difficult for the novice to navigate. As such, you may find it difficult to pin down stock picks within the sector that are a good fit for your portfolio without extensive research.
3. Educating Yourself on the Entire Sector Is Difficult
It’s always best to get a detailed understanding of not only the stocks, but the sectors in which you are invested. Then again, the service sector is a massive one that combines several industries, each with its own set of unique quirks.
This can be the downside to investing in such a massive sector. As a result of its sheer size, it can be difficult to educate yourself on the inner workings of the sector. If you find it difficult to understand what makes the sector tick, you’ll also find it difficult to time your entrances and exits. So, instead of looking at the sector as a whole, it’s best to pay attention to each individual subset of the service sector. For example, if you have a strong understanding of retailers or travel services, it’s best to keep your investment activities centered around these categories.
When Should You Invest in Service Stocks?
The answer to the timing question really depends on which types of service stocks you’re investing in. If you’re looking into utilities stocks that provide safe, stable growth with strong dividends, and your goal is stable growth with a side of income, any time is a good time.
Conversely, if you’re looking to take advantage of the momentum the travel industry experiences from time to time, it’s best to invest when economic conditions are positive.
To make the determination of when it’s best to invest in services, you have to first sort the service stocks you’re interested in into the cyclical and noncyclical buckets.
- Cyclical Service Stocks. Cyclical service stocks are in spaces like travel, entertainment, and other consumer discretionary services. These are the stocks that do best when economic conditions are positive and worst in times of economic hardship. If the service stock you’re interested in is a cyclical service stock, the best time to invest is when economic conditions are positive and seem to be continuing down that path.
- Noncyclical Service Stocks. Noncyclical service stocks, like consumer staples, are stocks that tend to see more stable growth and are not as affected by economic conditions. Not only are these stocks known for stable growth, they tend to pay strong dividends, making them great income plays. If steady growth and income are what you’re looking for, any time is a good time to invest in these. Also, if you’re looking for momentum when momentum is high and safe havens when declines are ahead, noncyclical service stocks are best when economic conditions start to take a turn for the worse.
How Much Should You Invest in Service Stocks?
It’s important to remember that diversification is important on a stock, sector, and asset class level. So, you should never invest 100% of your portfolio into any single stock or sector, for the most part.
The service sector is the one possible exception to that rule. This goes hand-in-hand with the fact that the sector is so massive. Because you can find cyclical and noncyclical stocks, high-risk and low-risk stocks, momentum stocks, income stocks, and stocks of all market caps in the service sector, this is the one sector that has the potential to take up the vast majority of your portfolio while still offering plenty of variety.
Nonetheless, as you invest, it’s important to keep diversification in mind. If you choose to invest 100% of your stock allocation in service stocks, make sure that your portfolio is highly diversified within the sector. If your appetite for risk is high, consider a higher ratio of cyclical service stocks to noncyclical service stocks. If you’re looking for lower risk and stable gains, make sure that your portfolio is weighted heavily toward the cyclical side of the equation.
Also, if you’re going to invest a large portion of your portfolio into service stocks, make sure to spread your investments across the various subsectors of the service industry. This will help to ensure that if one subset of the industry were to take a dive, your portfolio doesn’t take on substantial losses.
Consider Consumer-Focused ETFs
There are several investment-grade funds, like ETFs and mutual funds, focused on capitalizing on opportunities in the service sector. ETFs, mutual funds, and other investment-grade funds tend to be highly diversified, so they offer exposure to services in what many experts see as a safer way than picking individual service stocks.
ETFs and mutual funds focused on the service sector invest in a wide variety of service stocks, often ranging across multiple subsectors of the larger service sector, multiple market caps, and multiple different levels of risk. As such, this is a great way to gain widespread exposure to the industry. Some quality providers of service-focused investment-grade funds include Vanguard, iShares by Blackrock, and ProShares.
The service sector isn’t just unique and exciting — smart investment moves made in the sector also have the potential to be overwhelmingly profitable. While the size of the sector may be intimidating at first, the opportunities for diversification and the ability to provide options for every investor’s style make investing in service stocks a great concept for most.
As with any other sector, it’s important to diversify your investments and do your research before risking your first dime in the service sector. Nonetheless, if you take the time to do so, the rewards you experience could be incredible.