Shareholders in S4 Capital (LSE: SFOR) such as myself have become accustomed to strong growth over the past couple of years. So it has been a rude awakening to see the S4 Capital share price tumble this week. It has lost around 12% since Monday morning, at the time of writing this article earlier today.
Below I explain why this is — and whether I think it could present a buying opportunity to add more S4 Capital to my portfolio.
Strong results but high expectations
Looking at the share price movement since yesterday’s third-quarter trading statement, it’s hard to see why the update would lead to such a sharp correction in the S4 Capital share price.
The company affirmed its plans to double both revenues and profits in the current three-year period. It reported almost 56% like-for-like revenue growth in the third quarter. Adding in the impact of acquisitions, revenue more than doubled compared to the same quarter last year. Gross profit grew 42% like for like, or 92% including acquisitions.
So, why has the market punished S4 for what look like very strong results? I see two main reasons. The first is that the market has very high expectations of S4. The company has frequently upgraded its guidance and announced acquisitions when reporting trading updates. So the lack of an upgrade this time around seems to have caused the market to reconsider the heady share price appreciation of recent months.
Secondly, the company guided that profit margins will be smaller than expected. That is in line with the fact that revenues grew faster than profits. The company said that, as it scales up to serve large clients, it would need to invest more in systems and people. That could lead to smaller profits. A key risk with S4 is that revenue growth brings a higher cost base too, cutting profitability.
Will the S4 Capital share price keep falling?
Maybe there was too high an expectation built into the S4 Capital share price going into this week’s trading statement. So it’s not a surprise that the shares fell back. Indeed, I wrote about the company in August, “A lot of expectations are already built into the S4 Capital share price, so there is a risk that even good results could disappoint some investors and lead to a sell off.”
But I don’t think that will last for long if the business continues to perform well.
I think investing in systems and people necessary to grow the business is to be expected. Maybe the signalling around this could have been better managed, but it seems like the right strategic choice to me. S4 now has 7,000 staff and is fast emerging as one of the leading digital ad networks globally. In fact, overly fast expansion hurting service quality is a risk to both revenues and profits at S4. To keep growing healthily, it needs the right staff and technology. I think that’s worth paying for.
My next move on the S4 Capital share price
I remain bullish on S4 Capital. I bought more shares last week. While they have lost value following this week’s update, I do not plan to sell. In fact, I consider the recent price fall as a buying opportunity. I may use it to build my S4 Capital position further.
Christopher Ruane owns shares in S4 Capital. 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.
This post was originally published on Motley Fool
