First Advantage (FA)

Background screening provider First Advantage (NASDAQ:FA) reported Q1 CY2025 results topping the market’s revenue expectations, with sales up 109% year on year to $354.6 million. The company’s full-year revenue guidance of $1.55 billion at the midpoint came in 2.4% above analysts’ estimates. Its non-GAAP profit of $0.17 per share was 30.2% above analysts’ consensus estimates.

Company Overview

Processing approximately 100 million background checks annually across more than 200 countries and territories, First Advantage (NASDAQ:FA) provides employment background screening, identity verification, and compliance solutions to help companies manage hiring risks.

The Professional Staffing & HR Solutions subsector within Business Services is set to benefit from evolving workforce trends, including the rise of remote work and the gig economy. With companies casting a wider net to find talent due to remote work, the expertise of staffing and recruiting companies is even more valuable. For those who invest wisely, the use of predictive AI in recruitment and screening as well as automation in HR workflows can enhance efficiency and scalability. On the other hand, digitization means that talent discovery is less of a manual process, opening the door for tech-first platforms. Additionally, regulatory scrutiny around data privacy in HR is evolving and may require companies in this sector to change their go-to-market strategies over time.

First Advantage competes with other background screening providers including HireRight (NYSE:HRT), Sterling Check (NASDAQ:STER), and Accurate Background, as well as with broader human capital management companies that offer screening as part of their services, such as ADP (NASDAQ:ADP) and Equifax (NYSE:EFX).

A company’s long-term sales performance can indicate its overall quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years.

With $1.05 billion in revenue over the past 12 months, First Advantage is a small player in the business services space, which sometimes brings disadvantages compared to larger competitors benefiting from economies of scale and numerous distribution channels. On the bright side, it can grow faster because it has more room to expand.

As you can see below, First Advantage’s sales grew at an incredible 16.7% compounded annual growth rate over the last five years. This shows it had high demand, a useful starting point for our analysis.

Long-term growth is the most important, but within business services, a half-decade historical view may miss new innovations or demand cycles. First Advantage’s annualized revenue growth of 14.6% over the last two years is below its five-year trend, but we still think the results suggest healthy demand.

This quarter, First Advantage reported magnificent year-on-year revenue growth of 109%, and its $354.6 million of revenue beat Wall Street’s estimates by 2.9%.

Looking ahead, sell-side analysts expect revenue to grow 46.3% over the next 12 months, an improvement versus the last two years. This projection is eye-popping and implies its newer products and services will fuel better top-line performance.

Operating margin is an important measure of profitability as it shows the portion of revenue left after accounting for all core expenses – everything from the cost of goods sold to advertising and wages. It’s also useful for comparing profitability across companies with different levels of debt and tax rates because it excludes interest and taxes.

First Advantage was profitable over the last five years but held back by its large cost base. Its average operating margin of 5.1% was weak for a business services business.

Looking at the trend in its profitability, First Advantage’s operating margin decreased by 7.2 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. First Advantage’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.

In Q1, First Advantage generated an operating profit margin of 2.1%, up 2.6 percentage points year on year. This increase was a welcome development and shows it was more efficient.

Revenue trends explain a company’s historical growth, but the long-term change in earnings per share (EPS) points to the profitability of that growth – for example, a company could inflate its sales through excessive spending on advertising and promotions.

First Advantage’s EPS grew at an astounding 19.5% compounded annual growth rate over the last five years, higher than its 16.7% annualized revenue growth. However, we take this with a grain of salt because its operating margin didn’t expand and it didn’t repurchase its shares, meaning the delta came from reduced interest expenses or taxes.

In Q1, First Advantage reported EPS at $0.17, in line with the same quarter last year. This print easily cleared analysts’ estimates, and shareholders should be content with the results. Over the next 12 months, Wall Street expects First Advantage’s full-year EPS of $0.83 to grow 15.4%.

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

First Advantage has shown robust cash profitability, giving it an edge over its competitors and the ability to reinvest or return capital to investors. The company’s free cash flow margin averaged 13% over the last five years, quite impressive for a business services business. The divergence from its underwhelming operating margin stems from the add-back of non-cash charges like depreciation and stock-based compensation. GAAP operating profit expenses these line items, but free cash flow does not.

Taking a step back, we can see that First Advantage’s margin dropped by 17.1 percentage points during that time. If its declines continue, it could signal increasing investment needs and capital intensity.

First Advantage’s free cash flow clocked in at $8.36 million in Q1, equivalent to a 2.4% margin. The company’s cash profitability regressed as it was 16.5 percentage points lower than in the same quarter last year, which isn’t ideal considering its longer-term trend.

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was it capital-efficient? Enter ROIC, a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).

First Advantage historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 0.3%, lower than the typical cost of capital (how much it costs to raise money) for business services companies.

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, First Advantage’s ROIC averaged 1.2 percentage point decreases over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

First Advantage burned through $27.58 million of cash over the last year, and its $2.15 billion of debt exceeds the $172 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the First Advantage’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of First Advantage until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

We were impressed by how significantly First Advantage blew past analysts’ revenue, EPS, and EBITDA expectations this quarter. We were also excited its full-year EPS guidance outperformed Wall Street’s estimates. Zooming out, we think this quarter featured some important positives. The stock remained flat at $14.95 immediately after reporting.

Updated: May 22, 2025 at 11:35 PM EDT

The latest quarterly earnings matters, sure, but we actually think longer-term fundamentals and valuation matter more. Investors should consider all these pieces before deciding whether or not to invest in First Advantage.

Aside from its balance sheet, First Advantage is a pretty decent company. First off, its revenue growth was exceptional over the last five years and is expected to accelerate over the next 12 months. And while its relatively low ROIC suggests management has struggled to find compelling investment opportunities, its expanding adjusted operating margin shows the business has become more efficient. On top of that, its projected EPS for the next year implies the company’s fundamentals will improve.

First Advantage’s P/E ratio based on the next 12 months is 18.3x. Despite its notable business characteristics, we’d hold off for now because its balance sheet concerns us. If you’re interested in buying the stock, wait until its debt falls or its profits increase.

Wall Street analysts have a consensus one-year price target of $18.43 on the company (compared to the current share price of $16.89).

Want to invest in a High Quality big tech company? We’d point you in the direction of Microsoft and Google, which have durable competitive moats and strong fundamentals, factors that are large determinants of long-term market outperformance.

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