Business services providers use their specialized expertise to help enterprises streamline operations and cut costs. Market leaders have certainly capitalized on outsourcing trends and digital transformation initiatives to boost sales, helping fuel a 23.2% gain for the industry over the past six months - 9.6 percentage points higher than the S&P 500.

Regardless of these results, investors must exercise caution as many companies in this space are sensitive to the ebbs and flows of the broader economy. On that note, here are three services stocks we would avoid.

Cogent (CCOI)

Market Cap: $481.7 million

Operating a massive network spanning 20,000 miles of fiber optic cable and connecting to over 3,200 buildings worldwide, Cogent Communications (NASDAQ:CCOI) provides high-speed Internet access, private network services, and data center colocation to businesses and bandwidth-intensive organizations across 54 countries.

Why Do We Avoid CCOI?

1. Products and services are facing significant end-market challenges during this cycle as sales have declined by 5.6% annually over the last two years
2. Eroding returns on capital from an already low base indicate that management’s recent investments are destroying value
3. 10× net-debt-to-EBITDA ratio shows it’s overleveraged and increases the probability of shareholder dilution if things turn unexpectedly

Cogent’s stock price of $9.93 implies a valuation ratio of 8x forward EV-to-EBITDA. To fully understand why you should be careful with CCOI, check out our full research report (it’s free).

Booz Allen Hamilton (BAH)

Market Cap: $8.76 billion

With roots dating back to 1914 and deep ties to nearly all U.S. cabinet-level departments, Booz Allen Hamilton (NYSE:BAH) provides management consulting, technology services, and cybersecurity solutions primarily to U.S. government agencies and military branches.

Why Are We Cautious About BAH?

1. Sales were flat over the last two years, indicating it’s failed to expand this cycle
2. Estimated sales growth of 3.9% for the next 12 months is soft and implies weaker demand
3. Adjusted operating margin failed to increase over the last five years, indicating the company couldn’t optimize its expenses

At $72.80 per share, Booz Allen Hamilton trades at 11.6x forward P/E. Check out our free in-depth research report to learn more about why BAH doesn’t pass our bar.

Maximus (MMS)

Market Cap: $3.02 billion

With nearly 50 years of experience translating public policy into operational programs that serve millions of citizens, Maximus (NYSE:MMS) provides operational services, clinical assessments, and technology solutions to government agencies in the U.S. and internationally.

Why Are We Hesitant About MMS?

1. Sales were flat over the last two years, indicating it’s failed to expand this cycle
2. Estimated sales growth of 3.5% for the next 12 months is soft and implies weaker demand
3. Lacking free cash flow generation means it has few chances to reinvest for growth, repurchase shares, or distribute capital

Maximus is trading at $57.66 per share, or 7x forward P/E. Dive into our free research report to see why there are better opportunities than MMS.

Stocks We Like More

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