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This fast-growing small cap looks cheap to me after 30% profit growth

Underlying pre-tax profit rose by 30% to £36.7m last year at employment specialist Staffline Group (LSE: STAF), while its dividend rose by 29% to 25.8p.

Adding to the stock’s appeal is a fairly modest valuation. Staffline trades on a trailing P/E of just nine after today’s results.

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Against this positive backdrop, it’s hard to see why Staffline shares have lost 21% of their value over the last year. Today I’ll explain why I believe this stock offers an opportunity for small cap investors. I’ll also consider an alternative stock with less UK exposure.

A contrarian buy?

Staffline shares fell by more than 4% this morning, despite the group reporting a strong start to the year, with several new contracts and a record sales pipeline. In my view, the main reason for this weakness is that investors are uncertain about whether Staffline’s profits can be maintained.

The group has two main divisions, each of which contributes broadly equally to profits. In Staffing Services, Staffline draws on its database of 292,000 workers to provide up to 51,000 agency staff a day to more than 1,500 clients.

Staffline’s other division is referred to by the company as Employability. The firm has a number of contracts to run training and employment programmes for the Department of Work and Pensions and the Ministry of Justice.

Both lines of business could be vulnerable in a UK recession, or if Brexit results in a shortage of low-cost labour in the UK. It’s too early to say whether these problems will materialise, but Staffline’s management appears to have a good eye for profitable opportunities. I expect they will be able to manage these risks and the Brexit transition.

Analysts are cautious about the outlook for 2017 and expect earnings per share to rise by 3% to 116.1p. But with the shares trading on a forecast P/E of nine, I think the risks are reflected in the price. If earnings guidance is upgraded later this year, I believe the shares could perform strongly.

Should you look overseas?

Almost all of Staffline’s business is in the UK. If you’d prefer to invest in an employment business with more international exposure, then recruitment group Hays (LSE: HAS) could be an attractive choice. This firm’s focus is on placing professional and skilled technical staff in individual roles, giving it a different profile to Staffline.

Earlier this month, Hays reported 17% growth in net fee income during the final three months of last year.

But these gains were driven by strong growth in Asia Pacific (up 35%) and Continental Europe/RoW (up 30%). In the UK and Ireland, Hays saw its net fee income fall by 9%. The firm blamed this drop on “tough” conditions in public sector markets and weaker demand from private sector clients.

Despite this regional weakness, I believe Hays looks attractive at current levels. Broker forecasts have risen steadily since July. Further upgrades may be possible if expectations continue to improve.

As things stand, Hays trades on a 2016/17 P/E of 17, with a prospective yield of 2.7%. Hays has net cash on its balance sheet and is returning some of this cash to shareholders. The dividend is expected to rise by 20% next year, giving a forecast yield of 3.3%.

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Roland Head 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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