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Should you avoid this small-cap stock after today’s 20% decline?

Shares in marketing company System1 Group plunged in early deals after the firm issued yet another profits warning. 

In a trading update published this morning, the firm warned that “Q3 trading continued to be worse than anticipated” and thanks to its “normal lack of revenue visibility” management now “anticipates gross profit for the year to 31 March 2018 will be around 20% less than the prior year.”

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This is the latest in a string of warnings from the company which have helped push its share price down from a high of 1,040p during May of last year to 330p at time of writing, a decline of nearly 70%. 

Emerging problems 

System1’s issues first appeared during the first half of 2017 when it revealed that trading had slowed following the end of its fiscal year. The market didn’t punish the company too much at first, but then in mid-August, the firm confirmed investors’ worst fears, reporting “the slower than expected start to our fiscal year which we noted at the time of the announcement of our 2016/17 results on 15 June 2017 has continued since.” Thanks to these headwinds, management estimated a “6% to 11% fall in gross profit” at the time.

Unfortunately for the rest of the year, trading only deteriorated. At the end of October, management announced that due to the deferral of some major contracts, gross profit had actually declined 12% (in constant currency) year-on-year in the first half. 

Today’s dire update followed. 

Buy, sell or hold? 

How should investors react to this news? Well, it’s clear System1 is struggling and the company can no longer achieve the rapid rates of growth it once could. Still, management has been actively cutting costs and developing products in new markets. 

According to today’s update, while trading is proving slower than expected in the UK, the group is “on track to be close to break-even in Europe and to make an anticipated small loss in the US.” To help support growth, the company has £4.6m of cash in the bank with no debt. 

However, while there are green shoots to the System1 story, the outlook for the group is quite uncertain at the current time. A lack of profitability makes it harder to value the business, and even though management is undertaking initiatives to re-ignite growth, its success will ultimately depend on overall advertising spending growth, which management has little control over. As noted at the top of this article, the company is well aware of this, reflecting its statement highlighting the “normal lack of revenue visibility.

So overall, until there’s more clarity regarding the group’s outlook, I would avoid System1 for the time being. I believe that if a turnaround does take place, investors will have plenty of time to buy in again before the shares take off.

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Rupert Hargreaves owns no share 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.

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