The FTSE 250 is filled with younger-than-the-FTSE 100 enterprises that are hopefully on the path to achieving potential industry dominance. And some of the most promising ones are often trading at a premium. After all, success doesn’t always go unnoticed.
That certainly seems to be the case for digitalisation expert Kainos Group (LSE:KNOS). The stock has long been trading at high multiples. And even today, with a price-to-earnings (P/E) ratio of 34, it still looks expensive. However, after closer inspection, these shares might actually be a bargain. So much so, that I’ve just added some to my growth portfolio.
What does Kainos do?
The theme of digitalisation runs throughout this business. But its operations can be broken into three segments, two of which go hand in hand. The first and oldest focuses on working with other companies to find and eliminate operational bottlenecks using technological solutions. The latter two are built around the Workday platform.
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Workday is a human capital management system enabling businesses to unify human resources, finance, compliance, payroll, recruitment and more. For smaller corporations, integrating this solution is relatively straightforward. But for multinational enterprises, it can be quite a headache, which is where Kainos enters the picture.
The firm supports other companies implementing the Workday platform with a solid reputation for international expertise. At the same time, management has been investing in its own set of software tools that plug directly into Workday to be upsold to its own and other Workday customers.
Digging into the details
When it comes to performance, Kainos has yet to disappoint. Management seems to have a knack for beating analysts’ expectations. And it’s resulted in the average annual growth rate for revenue and earnings reaching 25.6% and 36.1%, respectively, over the last five years. What’s more, following a recent trading update, double-digit growth looks like it’s on track to continue into 2024, even with the current economic environment.
With exorbitant free cash flow generation and a debt-free balance sheet, it’s no wonder these shares were trading at a premium. But like many growth stocks with lofty valuations, the recent stock market correction punished Kainos severely, with around one-third of its market cap being wiped out since November last year.
Consequently, the stock is trading close to its 52-week low. But it still has that expensive-looking P/E ratio. So why do I think this is a bargain?
Growth at a reasonable price?
With management reiterating guidance in the previously mentioned trading update, the P/E ratio on a forward basis now stands at an estimated 23.6. That’s still not cheap by traditional standards. But when compared to the group’s five-year historical average of 35.4, it indicates Kainos may be on a relative 33% markdown right now!
Like all FTSE 250 companies, Kainos isn’t immune to risk. These shares can only be considered to be a bargain in my mind if everything continues to run smoothly.
Needless to say, that’s not guaranteed. With a new CEO, Russell Sloan, now at the helm after Brendan Mooney stepped down following 22 years of leadership, the ‘key-man’ impact remains unknown. In other words, the jury is still out on whether Sloan can fill Mooney’s shoes, potentially marking the end of Kainos’s glory days.
Regardless, I remain cautiously optimistic, especially at today’s relatively cheap entry point.
