The figures in today’s full-year results report from international recruitment specialist SThree (LSE: STHR) are impressive. In terms of constant currency exchange rates, revenue rose 13% compared to the year before and earnings per share shot up 20%. In a show of confidence in its outlook, the directors pushed up the total dividend for the year by 4%.
But looking at the action of the share price through last year, you’d never believe the company had been trading so well. By the middle of last January, the price was more than 30% lower than it had been at the start of 2018, although there’s been a little bounce over the past week or so in anticipation of today’s results.
A modest-looking valuation
I wrote about the firm a year ago when it had also delivered decent figures, declaring it a “top quality and value stock I’d buy right now.” I’m down on that call, but today’s numbers are even better than last year’s, so the value must look even more compelling. Indeed, at a share price of 279p, the forward-looking price-to-earnings multiple for the trading year to November 2020 sits just below eight, and the projected dividend yield is more than 5%. City analysts expect earnings to grow around 5% this year, 9% in 2020, and to cover the payment well over twice.
The valuation doesn’t look excessive, but I would observe that the rate of growth in earnings has been declining along with the earnings multiple the market has been assigning the firm. You can see that effect if you look at the five-year record. In the beginning, earnings were growing at high double-digit percentages, a much higher rate of growth than we’re seeing today. And back in 2014, the earnings multiple was as high as 19.
I think that earnings and valuation record shows us some of the effects of the inherent cyclicality in operations. It’s no use pretending otherwise, the recruitment sector booms and busts in accordance with general macro-economic conditions. However, I’m encouraged by the firm’s international footprint, which dilutes the volatility from any one national geography. In 2018, 29% of gross profit was earned in Germany, 21% in the USA, 15% in the UK, 15% in the Netherlands, and 20% in other countries around the world. All geographic segments displayed growth during the year, except for the UK and Ireland where gross profit slipped 5%.
Well positioned for growth
The outlook statement reveals that the directors think SThree is “well positioned” to grow further “despite turbulent political markets and economic pressure.” The question is, has the stock market been wrong about this strongly performing company? After all, if you’d held the shares since the beginning of 2014, you’d probably be disappointed. Despite all the progress with earnings over that period, the share price hasn’t gone any higher.
But I think it’s a big call to say the stock market has been wrong about the firm’s valuation. As profits grow in an unfolding macro-economic cycle, I think it’s rational for the market to keep marking down the valuation of a firm with cyclical operations.
