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 6.7% over the past six months. This drop was worse than the S&P 500’s 2.4% decline.

A cautious approach is imperative when dabbling in these companies as many are also sensitive to the ebbs and flows of the broader economy. On that note, here are three services stocks we’re passing on.

Arlo Technologies (ARLO)

Market Cap: $1.38 billion

Originally spun off from networking equipment maker Netgear in 2018, Arlo Technologies (NYSE: ARLO) provides cloud-based smart security devices and subscription services that help consumers and businesses monitor and protect their homes, properties, and loved ones.

Why Are We Cautious About ARLO?

1. Sales trends were unexciting over the last two years as its 3% annual growth was below the typical business services company
2. Revenue base of $505.8 million indicates it’s still subscale compared to its larger peers (though this creates opportunities to expand into untapped markets)
3. Ability to fund investments or reward shareholders with increased buybacks or dividends is restricted by its weak free cash flow margin of 1.6% for the last five years

At $12.92 per share, Arlo Technologies trades at 20.8x forward P/E. Check out our free in-depth research report to learn more about why ARLO doesn’t pass our bar.

Interface (TILE)

Market Cap: $1.23 billion

Pioneering carbon-neutral flooring since its founding in 1973, Interface (NASDAQ: TILE) is a global manufacturer of modular carpet tiles, luxury vinyl tile (LVT), and rubber flooring that specializes in carbon-neutral and sustainable flooring solutions.

Why Do We Avoid TILE?

1. Sales were flat over the last five years, indicating it’s failed to expand this cycle
2. Performance over the past five years shows each sale was less profitable, as its earnings per share fell by 16.7% annually
3. ROIC of 10.3% reflects management’s challenges in identifying attractive investment opportunities

Interface is trading at $22 per share, or 7.6x forward EV-to-EBITDA. Read our free research report to see why you should think twice about including TILE in your portfolio.

Korn Ferry (KFY)

Market Cap: $3.51 billion

With clients including 97% of the S&P 100 and operations in 103 offices across 51 countries, Korn Ferry (NYSE: KFY) is a global consulting firm that helps organizations design optimal structures, recruit talent, develop leaders, and create effective compensation strategies.

Why Do We Steer Clear of KFY?

1. Sales tumbled by 2% annually over the last two years, showing market trends are working against its favor during this cycle
2. Estimated sales growth of 1.6% for the next 12 months is soft and implies weaker demand
3. Earnings per share decreased by more than its revenue over the last two years, showing each sale was less profitable

Korn Ferry’s stock price of $68.02 implies a valuation ratio of 13.3x forward P/E. Check out our free in-depth research report to learn more about why KFY doesn’t pass our bar.

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