Back in November 2020, I suggested that shares in FTSE 250 IT provider Kainos (LSE: KNOS) could still push higher. That’s despite the stock already looking seriously expensive. Between then and yesterday, the share price has jumped 59%. This brings total gains over the last five years to 1,100%!
Given such superb momentum, does it make sense to be anything but bullish on the stock?
FTSE 250 growth stock
Based on the contents of today’s statement, my initial answer is an overwhelming ‘no’.
Trading from the beginning of April to date has been “resilient“, according to the company. That’s not a complete surprise given the importance of businesses continuing to invest in their digital capabilities.
Although no actual numbers were provided to expand on this, Kainos did say that both areas of its business — Digital Services and Workday Practice — were performing well. “Robust” demand for the former in the UK was supplemented by signs that the company was growing its client base in Europe and the US.
As a result of all this, the FTSE 250 constituent now expects full-year revenue will come in “ahead of current consensus forecasts“. Adjusted profit will also meet current forecasts.
How much is too much?
As solid a company as this is, I wonder if the valuation has gone from somewhat unpalatable to seriously stretched.
Kainos shares were trading for 41 times earnings when I last scrutinised the company towards the end of 2020. Before the market opened this morning, the very same stock changed hands for 53 times earnings. On top of this, the Belfast-based firm’s PEG (price/earnings-to-growth) ratio stands at 9. If I’m looking for value, this should really be coming in at less than 1! On this measure, I’d now be paying an awful lot for tapping in to this expansion.
Of course, I could be completely wrong. Kainos may be able to continue growing at such a rate that paying a lofty price now could still work out well for long-term investors like me. The fact that the company’s headcount has grown by almost 20% in just five months is a clear indication that demand for its services is unlikely to dry up soon.
Aside from this, Kainos also revealed today that it had snapped up Argentinian consulting business UNE. Having worked together since 2019, this purchase should further boost the company’s presence in the Americas region.
As noted when I’ve previously looked at the stock, the mid-cap also passes through my quality filters without issue. Great returns on capital? Check. High margins? Check. Sound finances? Check. In other words, this is the sort of share I should be backing the truck up for. Perhaps, like Terry Smith, I should be placing more emphasis on this than on the price paid.
However, there must be a point at where all the good news is priced in and buyers become thin on the ground. Moreover, Kainos mentioned today that the economic disruption caused by the pandemic would be “a feature of future trading periods“. I think that’s true for many/most UK companies. However, not all that many carry the same (excessive) price tag.
Watchlist-bound
Interim numbers from this high-flying FTSE 250 stock are due on 15 November. If I held the stock since 2016 (and I wish I had), I don’t think I could resist taking at least some profit at this point.
Regrettably, KNOS stays on my watchlist.
