Business services providers play a critical role for enterprises, assisting them with everything from new hardware integrations to consulting and marketing. But cutbacks in corporate spending and the threat of new AI products have kept sentiment in check, and over the past six months, the industry has tumbled by 9%. This drawdown was worse than the S&P 500’s 1.9% decline.
Investors should tread carefully as many of these companies are also cyclical, and any misstep can have you catching a falling knife. On that note, here are three services stocks that may face trouble.
MillerKnoll (MLKN)
Market Cap: $1.15 billion
Created through the 2021 merger of industry icons Herman Miller and Knoll, MillerKnoll (NASDAQ: MLKN) designs, manufactures, and distributes interior furnishings for offices, healthcare facilities, educational settings, and homes worldwide.
Why Do We Steer Clear of MLKN?
- Customers postponed purchases of its products and services this cycle as its revenue declined by 7.8% annually over the last two years
- Performance over the past five years shows its incremental sales were much less profitable, as its earnings per share fell by 9.6% annually
- Capital intensity has ramped up over the last five years as its free cash flow margin decreased by 4.7 percentage points
At $17 per share, MillerKnoll trades at 6.9x forward P/E. Read our free research report to see why you should think twice about including MLKN in your portfolio.
IBM (IBM)
Market Cap: $239.4 billion
With a corporate history spanning over a century and once known for its iconic mainframe computers, IBM (NYSE: IBM) provides hybrid cloud computing platforms, AI solutions, consulting services, and enterprise infrastructure to help businesses modernize their operations.
Why Do We Pass on IBM?
- Sales tumbled by 1.3% annually over the last five years, showing market trends are working against its favor during this cycle
- Flat earnings per share over the last five years lagged its peers
- Underwhelming 11.4% return on capital reflects management’s difficulties in finding profitable growth opportunities
IBM’s stock price of $263 implies a valuation ratio of 24.1x forward P/E. To fully understand why you should be careful with IBM, check out our full research report (it’s free).
Applied Digital (APLD)
Market Cap: $1.71 billion
Pivoting from its origins in cryptocurrency mining to become a key player in the AI infrastructure boom, Applied Digital (NASDAQ: APLD) designs and operates specialized data centers that provide high-performance computing infrastructure for artificial intelligence and blockchain applications.
Why Does APLD Worry Us?
- Historically negative EPS is a worrisome sign for conservative investors and obscures its long-term earnings potential
- Cash-burning history makes us doubt the long-term viability of its business model
- Unfavorable liquidity position could lead to additional equity financing that dilutes shareholders
Applied Digital is trading at $7.58 per share, or 13.2x forward EV-to-EBITDA. Check out our free in-depth research report to learn more about why APLD doesn’t pass our bar.
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