This growth stock looks 25% undervalued to me

Leading in British intelligent technology and software solutions, this growth stock looks like a worthy addition to Oliver Rodzianko’s portfolio.

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Key Points

  • Kainos is a top tech investment in the UK, recognised by Microsoft's CEO for its AI and digital service prowess, offering solutions to institutions across the globe.
  • It excels in business services, reducing costs for clients, with recession-resistant shares due to its role in decreasing overhead expenses and extensive AI integration.
  • Despite high growth rates and being potentially undervalued, risks include current liabilities and potential competition or acquisition approaches from industry giants.

I consider this growth stock to be one of the best technology investments in Britain as I write. In fact, I think there might be none better.

Don’t just take my word for it. When Microsoft CEO Satya Nadella came to London earlier in the year to meet UK businesses about AI, Kainos Group (LSE:KNOS) was one of seven partners invited to the table.

Its use of next-generation intelligence technology is to help leading global institutions manage their workloads more effectively. It does this through digital services and Workday implementation.

Why I think the company is great

First of all, what strikes me as valuable about Kainos is that it’s a business-to-business enterprise. I like this because often, they’re helping firms reduce costs.

If it comes time to cut budgets, businesses are unlikely to fire the firms that are already reducing their expenses. That’s why Kainos shares have some recession resistance to them.

Its integration of AI is also expansive. It includes advanced capabilities in machine learning, fraud detection and digital assistance.

Notable achievements include helping UK government departments identify fraud and increase administration efficiency at hospitals and care centres catering to over half a million patients in total.

It’s leading in the UK at simple, intelligent technology processes, and I commend it for that.

Good growth and good value

Kainos’s strengths aren’t purely operational, they’ve also translated into financials that I consider excellent.

First of all, this is a high-growth enterprise. Over the past three years, the company has grown its earnings at an annual rate of 37%. That is very fast.

But I’ve looked at analyst estimates, and over the next three years, growth is set to slow considerably to around 13% per year. That explains why the price is down over 50% as I write.

From my analysis, the market has been efficient here in pricing the shares according to future growth expectations. But I still think it’s selling at a discount.

With its growth higher than most of its industry peers, I feel it deserves a premium valuation. Just because the future expectations are lower, that doesn’t mean the price should be down this much.

I could have a 25% discount on my hands here, as its price-to-earnings ratio has dropped from its 10-year median of 40 to 30 at this time.

A look at the risks

Kainos has slightly more liabilities than usual at the moment when comparing its current balance sheet against the reports from the past decade.

Therefore, it needs to be careful how it allocates its net income right now.

It has quite a lot of accounts that are still due to be paid, and I think it could benefit from prioritising these over certain business expansions until the balance sheet is a tad more stable.

Also, let’s not forget that business is both about partnership and competition. Microsoft has the resources to easily outcompete or even make an acquisition approach on Kainos. The latter wouldn’t necessarily be bad for Kainos shareholders, but the former certainly would.

A very worthy business

I love the look of these shares, and while my portfolio only has a dozen select companies in it, Kainos might make the cut at some point later in the year.

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.

Oliver Rodzianko has positions in Microsoft. The Motley Fool UK has recommended Kainos Group Plc, Microsoft, and Workday. 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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