Over the past six months, Mercury Systems’s shares (currently trading at $69.68) have posted a disappointing 10% loss while the S&P 500 was down 4.8%. This might have investors contemplating their next move.

Is now the time to buy Mercury Systems, or should you be careful about including it in your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.

Why Do We Think Mercury Systems Will Underperform?

Even with the cheaper entry price, we're swiping left on Mercury Systems for now. Here are three reasons we avoid MRCY and a stock we'd rather own.

1. Long-Term Revenue Growth Disappoints

Examining a company’s long-term performance can provide clues about its quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Unfortunately, Mercury Systems’s 2.3% annualized revenue growth over the last five years was sluggish. This fell short of our benchmarks.

2. Shrinking Operating Margin

Operating margin is a key measure of profitability. Think of it as net income - the bottom line - excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.

Looking at the trend in its profitability, Mercury Systems’s operating margin decreased by 5.4 percentage points over the last five years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Mercury Systems’s performance was poor no matter how you look at it - it shows that costs were rising and it couldn’t pass them onto its customers. Its operating margin for the trailing 12 months was negative 1.4%.

3. EPS Trending Down

Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.

Sadly for Mercury Systems, its EPS declined by 16.7% annually over the last five years while its revenue grew by 2.3%. This tells us the company became less profitable on a per-share basis as it expanded.

Final Judgment

We cheer for all companies making their customers lives easier, but in the case of Mercury Systems, we’ll be cheering from the sidelines. After the recent drawdown, the stock trades at 64.5× forward P/E (or $69.68 per share). At this valuation, there’s a lot of good news priced in - we think other companies feature superior fundamentals at the moment. We’d recommend looking at the most dominant software business in the world.

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