Is this hidden growth stock a buy after falling 10%?

With a market value of only £37m, shares in Styles and Wood Group (LSE: STY) fly under the radar of most investors despite the company’s explosive growth over the past few years. 

Styles and Wood has been a recovery play since the financial crisis. Heading into the crisis, the shop fitting group was overleveraged, and a reliance on business customers meant that when the crisis hit, business dried up and the company was forced into survival mode to meet debt obligations. 

However, over the past three years, the company’s turnaround plan has started to pay off. Last year the firm reported a net profit of £2.5m on revenue of £115m, a five-year high and for full-year 2016 analysts have pencilled-in a net profit of just under £3m. 

Missed forecasts 

Unfortunately, shares in Styles and Wood are falling this morning after the company warned that it might not meet City forecasts for fiscal 2016. 

Specifically, management announced this morning that 2016 revenue is expected to fall 9% as a significant proportion of proceeds from work will be recognised during the 2017 fiscal period. While this may look like a profit warning, management has reassured that pre-tax profit for 2016 is actually set to be in line with City forecasts. What’s more, it looks like 2017 is going to be another year of growth for the firm. 

The order book for the first 10 weeks of the fiscal year is up 35% on the same period a year ago, boosted by the recent acquisitions of Keysource and GDM Group, which bodes well for forward earnings growth. City analysts have pencilled-in a pre-tax profit figure of £4.5m for 2017 and earnings per share of 51p. 

Time to buy? 

There’s no denying that Styles and Wood has undergone a tremendous transformation during the past decade. Management has slashed debt from £13.2m at the end of 2012 to £2m at the end of 2015. If debt reduction continues at current rates, the company will have a net cash balance by the end of 2017. Book value per share has improved from -213p per share at the end of 2012, to -22.3p at the end of 2015. 

Still, despite the group’s impressive turnaround, Styles and Wood remains extremely exposed to any economic turbulence. The firm’s operating profit margin is razor thin, averaging 2% since 2012, which leaves no room for error. So, even though the company might look as if it is back on a firmer footing today, it won’t take much for losses to return. This lack of financial wiggle room explains why the company trades at such a low valuation. Based on current City forecasts, the shares trade at a forward P/E of 9.2, despite projected earnings growth of 32%. 

The bottom line 

Overall, the decision of whether or not to buy shares in Styles and Wood comes down to your own view of the company. If you believe the firm’s outlook will continue to improve, the low valuation could be attractive. On the other hand, if you think the company lacks the qualities of a good investment, it may be wise to stay away.  

Make money, not mistakes

Buying shares that are standing on shaky foundations just because they look cheap can be a poor investment strategy. 

To help you avoid this key mistake, the Motley Fool has put together this new free report entitled The Worst Mistakes Investors Make.

These mistakes can cost you thousands over your investing career but the best part is, this report is free to download. 

The report is a collection of Foolish wisdom that should help you avoid making some of the worst mistakes investors make.

Click here to get your copy today.

Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.