Down 42%! Is this a long-awaited buying opportunity for Kainos shares?

After a slump in Kainos shares this week, they’re now over two-fifths below their 12-month high. Does our writer scent a bargain at this price?

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I have had my eye on software company Kainos (LSE: KNOS) for a while. I like its government contracts and strong position helping companies use Workday software. So why have I held back on buying Kainos shares? I simply did not feel the price was attractive. Other investors clearly liked the business too and had pushed the share price up accordingly.

But after Kainos shares fell a fifth yesterday (13 November), they are now 42% down from their 12-month high. Does that finally offer me the sort of buying opportunity I have been waiting for?

Looking under the bonnet

The first thing to when a share falls a fifth in one day, let alone over 40% in under 12 months, is to look for possible explanations.

Yesterday’s fall followed the release of interim results that went down like a lead balloon.

But overall, they seemed pretty good to me. Revenues were 7% higher than the prior year period, while pre-tax profit grew 12%. The interim dividend was lifted 5%.

One element that concerned investors was a 9% fall in bookings.

So, while the company maintained an upbeat tone about its financial outlook, the reality is that the contracts finalised during the first half were collectively worth 9% less than in the prior year.

That could suggest the company is starting to feel the impact of clients tightening their belts, or postponing non-critical IT spend.

Valuing Kainos

As a long-term investor, I do not pay much attention to short-term price movements.

Instead, like famous investor Warren Buffett, I aim to buy into a company if I think its long-term value is substantially greater than its current share price.

Even after the fall in Kainos shares, the Belfast-based software specialist trades on a price-to-earnings (P/E) ratio of 29.

Admittedly that is lower than software giant Microsoft and its P/E ratio of 36, but Kainos is a much smaller, less proven business than Microsoft. I think 36 is too high for any business, but I also think 29 remains too high for Kainos.

After all, it continues to grow at a fair clip but not a stellar one. The sort of valuation it currently commands suggests a business with exceptionally strong growth prospects.

I do not see Kainos’s current growth in that way — and the decline in bookings suggests things might be heading in the wrong direction.

Buy now or wait?

Every business has its fair price. As an investor, I think it is important to pay at or below that price, not above it.

Kainos is solidly profitable, has a cash pile of £113m, a large installed user base and is the leading pan-European Workday consulting specialist. Those are all strengths that mean I would happily add it to my portfolio at the right price.

For now, though, I continue to see the shares as overvalued. So I have no plans to buy just yet. I will keep on waiting, as I have for years.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Kainos Group Plc and Microsoft. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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