Business services providers play a critical role for enterprises, assisting them with everything from new hardware integrations to consulting and marketing. Furthermore, the demand for their offerings is rising as more clients outsource non-core functions, a trend that has enabled the industry to return 20.4% over the past six months, almost identical to the S&P 500.

Nevertheless, investors should tread carefully as many companies in this space are cyclical due to their reliance on corporate spending budgets. On that note, here are three services stocks we’re steering clear of.

Knowles (KN)

Market Cap: $2.00 billion

With roots dating back to 1946 and a focus on components that must perform flawlessly in critical situations, Knowles (NYSE: KN) designs and manufactures specialized electronic components like high-performance capacitors, microphones, and speakers for medical technology, defense, and industrial applications.

Why Is KN Risky?

1. Annual sales declines of 3.7% for the past five years show its products and services struggled to connect with the market during this cycle
2. Subscale operations are evident in its revenue base of $573.5 million, meaning it has fewer distribution channels than its larger rivals
3. Below-average returns on capital indicate management struggled to find compelling investment opportunities, and its shrinking returns suggest its past profit sources are losing steam

Knowles is trading at $23.33 per share, or 19.6x forward P/E. Dive into our free research report to see why there are better opportunities than KN.

ABM (ABM)

Market Cap: $2.63 billion

With roots dating back to 1909 as a window washing company, ABM Industries (NYSE: ABM) provides integrated facility management, infrastructure, and mobility solutions across various sectors including commercial, manufacturing, education, and aviation.

Why Does ABM Give Us Pause?

1. Core business is underperforming as its organic revenue has disappointed over the past two years, suggesting it might need acquisitions to stimulate growth
2. Performance over the past two years shows its incremental sales were less profitable, as its 1.2% annual earnings per share growth trailed its revenue gains
3. Free cash flow margin dropped by 6.4 percentage points over the last five years, implying the company became more capital intensive as competition picked up

At $43 per share, ABM trades at 10.9x forward P/E. To fully understand why you should be careful with ABM, check out our full research report (it’s free for active Edge members).

Avnet (AVT)

Market Cap: $3.94 billion

With a century-long history of adapting to technological evolution, Avnet (NASDAQ: AVT) is a global electronic components distributor that connects manufacturers of semiconductors and other electronic parts with businesses that need these components.

Why Do We Think Twice About AVT?

1. Annual sales declines of 7.2% for the past two years show its products and services struggled to connect with the market during this cycle
2. Earnings per share have contracted by 33.8% annually over the last two years, a headwind for returns as stock prices often echo long-term EPS performance
3. Low free cash flow margin of -0.3% for the last five years gives it little breathing room, constraining its ability to self-fund growth or return capital to shareholders

Avnet’s stock price of $48.45 implies a valuation ratio of 9.8x forward P/E. Read our free research report to see why you should think twice about including AVT in your portfolio.

Stocks We Like More

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