Is this former favourite growth stock a falling knife to catch after dropping 25% today?

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Shares in System1(LSE: SYS1) have lost a fifth of their value in early deals this morning after the company issued a profit warning. In a trading statement released prior to the company's AGM today, chairman Ken Ford stated: "The slower than expected start to ourfinancial year which we noted at the time of the announcement of our 2016/17 results on 15 June 2017 has continued since then, and we now expect H1 Gross Profit (our main top line performance indicator) to be 6-11% lower than the prior year."

The statement goes on to say that management expects gross profit to move back to growth in the second half of the year.

It seems System1's problems stem from higher costs relating to the group's expansion plans. The statement today notes that: "H1 2017/18 costs will be some 15% higher than last year" reflecting "investment in senior hires in the support future growth in both our Research and new Advertising Agency businesses." One-off severance charges have also pushed costs higher, although these actions are expected to save £0.5m per annum going forward. For the full fiscal year, "costs are currently expected to grow by around 10%."

After taking all of these charges into account, the group anticipates first half pre-tax profit to be a little over break-even, against £2.8m a year earlier. For the year, pre-tax profit is expected to decline approximately 10% to 15%.


Looking at these figures, it is no surprise that shares in System1 have been falling so fast this morning.

Prior to the announcement, shares in the marketing services agency were trading at a forward P/E of 21.2 as City analysts have pencilled in earnings per share growth of 30% for the year ending 31 March 2018. Pre-tax profit was expected to rise to £7.9m from £6.3m achieved last year.

These forecasts are now out of date, and a lack of growth means the growth multiple is no longer justified. As of yet, City analysts have yet to revise their forecasts based on today's news. But based on historical figures, I estimate for the full-year System1's earnings per share could fall back to around 27p, indicating that the shares still trade at around 24 times forward earnings. With this being the case, unless the company can instigate a dramatic turnaround, the shares could have further to fall as they re-rate to a lower, ex-growth multiple.

That being said, considering the firm's historical strength, and the investment in people to help improve overall performance, System1 looks set to return to growth next year. So, the market might think twice about marking the shares down further.

If the company can return to growth next year, this could be a great buying opportunity for long-term investors, although if costs continue to rise faster than revenues, there will be further pain ahead for investors.

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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.