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 certainly contributed to services stocks’ recent underperformance - over the past six months, the industry’s 1.8% gain has fallen behind the S&P 500’s 6.9% rise.

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

Napco (NSSC)

Market Cap: $1.06 billion

Protecting everything from schools to government facilities since 1969, Napco Security Technologies (NASDAQ: NSSC) manufactures electronic security devices, access control systems, and communication services for intrusion and fire alarm systems.

Why Does NSSC Worry Us?

1. Muted 3.7% annual revenue growth over the last two years shows its demand lagged behind its business services peers
2. Modest revenue base of $181.2 million gives it less fixed cost leverage and fewer distribution channels than larger companies
3. Demand will likely fall over the next 12 months as Wall Street expects flat revenue

Napco’s stock price of $29.78 implies a valuation ratio of 25.4x forward P/E. If you’re considering NSSC for your portfolio, see our FREE research report to learn more.

ScanSource (SCSC)

Market Cap: $952 million

Operating as a crucial link in the technology supply chain since 1992, ScanSource (NASDAQ: SCSC) is a hybrid distributor that connects hardware, software, and cloud services from technology suppliers to resellers and business customers.

Why Do We Pass on SCSC?

1. Products and services are facing significant end-market challenges during this cycle as sales have declined by 1.5% annually over the last five years
2. Earnings per share have contracted by 8.5% annually over the last two years, a headwind for returns as stock prices often echo long-term EPS performance
3. Low returns on capital reflect management’s struggle to allocate funds effectively

At $42.13 per share, ScanSource trades at 11.3x forward P/E. To fully understand why you should be careful with SCSC, check out our full research report (it’s free).

Taboola (TBLA)

Market Cap: $1.19 billion

Often appearing as those "You May Also Like" or "Recommended For You" boxes at the bottom of news articles, Taboola (NASDAQ: TBLA) operates a digital platform that recommends personalized content to users across publisher websites, helping both publishers monetize their sites and advertisers reach target audiences.

Why Is TBLA Not Exciting?

1. Falling earnings per share over the last three years has some investors worried as stock prices ultimately follow EPS over the long term
2. Free cash flow margin dropped by 2,531.6 percentage points over the last five years, implying the company became more capital intensive as competition picked up
3. Shrinking returns on capital from an already weak position reveal that neither previous nor ongoing investments are yielding the desired results

Taboola is trading at $3.65 per share, or 7x forward EV-to-EBITDA. Check out our free in-depth research report to learn more about why TBLA doesn’t pass our bar.

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