Shares in Micro Focus (LSE: MCRO) have taken a hammering over the past 12 months. The company, which is one of the largest tech firms in the UK, has struggled to integrate a significant acquisition and, as a result, has issued one serious profit warning that has sent investors running for the hills.
Since the beginning of the year, shares in the company have fallen by around 40%, excluding dividends.
After these declines, value hunters might be tempted to buy into Micro Focus. But is the stock really a bargain?
After recent declines, shares in Micro Focus do look cheap. They’re trading at a forward earnings multiple of just 10.5, at the time of writing. Usually, this discount valuation would attract me to any business, especially because shares in this FTSE 100 tech darling are trading at a significant discount to the rest of the UK Software and IT Services Industry (trading at a P/E of 17.7).
However, I’m worried about what the future holds for the business. Management has struggled to integrate the company’s largest acquisition ever over the past year, which is concerning because Micro Focus’ primary line of business is combining and bringing old software systems up to date. The profit warning doesn’t, in my view, bode well for future growth.
The deal also lumped the enlarged company with a mountain of debt ($4.5bn), which will take some time to pay down. Even though City analysts are expecting the group to report earnings growth of 56% for 2018 and a net profit of $857m, I want to see some concrete evidence that growth has returned before supporting this struggling enterprise.
In the meantime, I think small-cap GB (LSE: GBG) deserves a place in your portfolio.
At first glance, compared to Micro Focus, shares in this company don’t seem particularly attractive because they’re changing hands for around 30 times fiscal 2019 earnings. However, unlike Mirco Focus, GB is growing rapidly and has a large, growing mountain of cash on its balance sheet.
The company’s half-year report, which was published this morning, revealed revenue growth of 9% year-on-year and the firm expects to hit City forecasts for the full-year, based on current trading. Analysts are currently projecting a net profit of £22.4m for fiscal 2019, more than double last year’s figure.
As I noted last time I covered the stock, one of the reasons why I think GB could be a fantastic growth investment is because the company is carving out a niche for itself in the data security business, an industry that’s only going to grow in size as the world becomes ever-more connected. What’s more, GB has high levels of recurring revenue and steadily improving margins, which I think are highly desirable qualities in any business.
With this being the case, even though the stock might look a little pricey, I think it’s worth buying today.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Micro Focus. 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.