S4 Capital’s share price has fallen below 700p. Is this a buying opportunity?

S4 Capital’s share price has fallen 10% today on the back of a trading update. Edward Sheldon looks at whether this is a buying opportunity.

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Shares in digital advertising firm S4 Capital (LSE: SFOR) are having a bad day today. As I wrote this, the stock – which has risen around 60% over the last year – was down over 10% and trading just below 700p (although it has since edged up slightly).

When I last covered S4, in July, I said that there was a lot to like about this tech-focused company. However, the stock looked fully valued to me at the time. Has today’s share price fall created a buying opportunity for me? Let’s take a look.

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Q3 trading update

The share price fall today is the result of the company’s third-quarter trading update posted this morning. There were certain things in the update that the market didn’t like.

Personally, I thought the trading update was quite good overall. For the quarter, revenue was up 106% in total and up almost 56% on a like-for-like basis. Meanwhile, Q3 gross profit was up 92% in total and up over 42% like-for-like.

Encouragingly, it said it has now signed six ‘whoppers’ (large clients) and has identified 19 more potential ones. And it continues to trade “extremely well” in line with its top-line objectives for 2021 and that it was seeing no negative impact from inflation, supply chain issues, or Apple‘s privacy changes.

Why S4 Capital’s share price just tanked

What the market didn’t like was the fact that the company advised that it’s set to make extra investments in the near term to boost growth.

The pandemic has proven to be an accelerator of digital marketing transformation and we are taking full advantage of this opportunity by choosing to invest a proportion of our EBITDA margin in growth,” wrote Executive Chairman Sir Martin Sorrell in the update.

These investments will hit profits in the short term and as a result of this development, analysts have reduced their earnings forecasts for the next few years.

Jefferies, for example, has cut its EBITDA estimate by 6.5%, 4.6%, and 2.6% for FY21, FY22 and FY23 respectively (and lowered its price target to 930p from 960p). Meanwhile, Peel Hunt has reduced its FY21 earnings per share (EPS) estimate by 10%.

Lower earnings in the short term are not ideal from an investment point of view. However, they’re also not the end of the world, especially if they help boost growth in the long run.

Should I buy the shares now?

Given that the company is set to make extra investments to support growth, it’s now a little harder to put an accurate valuation on the stock.

Before today, analysts were expecting EPS of 12.8p this year and 19.1p next year. However, earnings are now likely to be lower than this.

To keep things simple, I’m going to follow Peel Hunt and reduce my FY21 EPS estimate by 10%. I’m also going to reduce my FY22 EPS estimate by the same amount. That gives EPS forecasts of 11.5p for this year and 17.2p for next. Using these figures, S4 has a forward-looking P/E ratio of 60 for this year and 40 for next year.

These figures are still pretty high meaning there’s not a huge margin of safety here. If growth slows, the stock could take a hit. That said, a P/E ratio of 40 is not outrageous, to my mind, given the level of growth here.

At that valuation, I’d be comfortable taking a small position.

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Edward Sheldon owns shares of Apple. The Motley Fool UK has recommended Apple. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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