Why this growth stock could record a 0% return in the next 2 years

This company’s shares appear to be trading at fair value so are there better options available?

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One challenge facing investors is identifying attractive investments versus attractive businesses. In other words, a company may be performing well and release an upbeat update. Its profit may be set to rise in the current year and in future. However, if its shares are already trading at fair value when this outlook is factored-in, it may prove to be a somewhat disappointing investment. Reporting on Wednesday was a company which appears to fit that description.

Impressive performance

That company was recruitment specialist Hays (LSE: HAS). Its first-half results showed a rise in net fees of 17% and operating profit which was 16% higher. It recorded strong performance in its Continental Europe & Rest of World division, with net fees rising by 10% and operating profit up 6%. Similarly, in its Asia Pacific segment, net fees moved 6% higher and operating profit was 12% up on the same period of the prior year.

However, in the UK Hays saw net fees fall by 10%, while operating profit was 29% lower. This was mostly due to the uncertainty brought about by Brexit. The company though, has reacted positively to the tough trading conditions in the UK by reducing costs. It has also seen a degree of stabilisation and its performance in the UK in the second half of the year could therefore be better.

Valuation

Partly due to the slowdown in demand for recruitment services in the UK, Hays is expected to record a reduction in its earnings growth rate. While in each of the last three years it has delivered a double-digit rise in earnings, its bottom line is expected to rise by 7% this year and by a further 6% next year.

This growth rate is roughly in line with that of the wider index. However, Hays continues to trade on a relatively premium valuation, with it having a price-to-earnings (P/E) ratio of 17.5. This is almost identical to its historic average P/E ratio over the last five years, which indicates that the company’s shares are fully valued. And since its earnings growth rate in recent years has been higher than its forecast growth rate, it could be argued that Hays’s rating will experience downward pressure over the next couple of years. This could offset any profit growth in 2017 and 2018, thereby giving a potential 0% return for investors.

Outlook

While Hays faces an uncertain future due to an unclear macroeconomic outlook, there are still opportunities within the recruitment sector. For example, Pagegroup (LSE: PAGE) is expected to record a rise in its bottom line of 10% next year. It trades on a much lower rating than its historic average, with the company’s mean P/E in the last four years being 26.6. Assuming it reverts to its average over the medium term and is able to meet its guidance, Pagegroup could be trading at as much as 651p per share versus its current price of 420p.

Clearly, a 55% return may not be realistic, since Pagegroup’s forecasts may be downgraded. But it offers a much wider margin of safety than its rival at the present time. Therefore, it seems to be a much more attractive investment proposition.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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