Why might an investor buy a value stock in a Stocks and Shares ISA? Well, a good one offers steady earnings, dividends, and the potential for a share price recovery due to a low valuation.

By contrast, there’s the value trap. This is a stock that looks cheap on paper but stays that way due to weak growth, declining earnings, or other problems that prevent a proper recovery. One notorious example is BT Group, whose share price was higher decades ago than it is today. 

Here, I’ll highlight a small-cap stock that I think does look good value and might be worth considering for long-term investors.

Growing law firm

The share in question is AIM-listed Knights Group (LSE: KGH). This is a legal and professional services company that operates as a corporate-style business rather than a traditional partnership-based law firm.

What does that mean? One difference is that the group offers a wider range of services, spanning corporate law, real estate, employment, dispute resolution and more. It also offers advisory services in debt management and wealth planning, and is moving into growth areas like new homes and immigration. 

Over the past few years, it’s snapped up more than two dozen local law firms to expand its expertise and geographical presence. Indeed, it’s now among the leading legal and professional services businesses outside London. 

Revenue has grown briskly from £52.7m in 2019 to a forecast £164m this financial year (ending April). Earnings have also motored higher, growing at a compound annual rate of about 26% over that time.

The company also pays a dividend, with the forecast yield for next year sitting at 4.3%. This prospective payout is comfortably covered almost five times over by forecast earnings. While not guaranteed, this at least suggests there’s significant scope for dividend growth in future.

Some issues to bear in mind

As the chart above shows, the share price tumbled in early 2022. This came after the company issued a profit warning, blaming Covid-related office absences for disrupting operations. Fair enough.

But another factor since then has been higher interest rates. At the end of October, Knights had £50m in net debt, which is quite high for a company with a £101m market cap.

Now, the interest coverage ratio is around 4.1, meaning the debt is manageable and the firm can meet its interest payments. However, high rates could slow its acquisition-driven growth. In fact, next year’s forecast revenue growth of 6%-7% is well below that of earlier years.

Meanwhile, a sluggish UK economy probably isn’t helping business.

My verdict

That said, I see a lot of value here. The stock currently sits at 118p, having fallen 76% since September 2020. This leaves it trading at an ultra-low price-to-earnings ratio of 4.7 for next year!

Looking ahead, earnings seem set to grow strongly as Knights expands into higher-margin legal services, while strategically reducing lower-margin areas like insolvency. And the interim dividend was hiked 9.3% earlier this month, meaning there’s growing income on offer.

Finally, once interest rates come down, the share price could recover strongly as borrowing costs ease and the economy steadily improves (hopefully).

With strong earnings growth, rising dividends, and a dirt-cheap valuation, Knights looks to be positioned to do well when market conditions improve. I reckon it’s worth considering.