When looking for top contenders to add to a portfolio, the FTSE 250 offers a lot of overlooked companies with great future prospects. In my opinion, Kainos (LSE:KNOS) is one such company.
I think the investment, despite dropping 14% in price in a month and being around 50% below all-time highs, is about to see much brighter days ahead. What’s more, because it’s now much cheaper, the future returns I get if I invest could be maximised as a result.
An undervalued UK tech firm
Researching technology investments is what I do for a living, and after multiple rounds of research into Kainos, I consider it one of the leading contenders in the British technology scene.
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I particularly like it because it is smaller than its major competitors, Softcat and Computacenter. This gives it more room to grow. Its lower market cap also opens it up to more price inefficiencies in the stock market.
For example, the current 50% sell-off from all-time highs is too much, in my opinion. This overselling is much less likely to occur in FTSE 100 constituents and very rare in American big tech companies like Microsoft.
The future is likely bright
Leading analysts have predicted that the company’s earnings per share are likely to grow at 11% per year over the next three years on average. This has been underappreciated by the market, in my opinion. Pessimism around the shares has increased because its revenue has only grown a mere 1% over the past year.
The last 12 months have been a period of economic stagnation for many industries. High interest rates and high levels of inflation have curbed consumer and business spending.
However, these conditions look set to begin easing through 2025 and into 2026. As a result, I think the pessimism priced into Kainos shares at the moment isn’t going to last. As Warren Buffett once said: “Be fearful when others are greedy, and be greedy when others are fearful.”
What could go wrong?
One of the core ways that I protect myself from the outset of anything going wrong in one investment is healthy diversification. Ten or more strong stocks spread across various industries offers decent protection.
Additionally, as a long-term investor, which is also the Foolish way, I need to understand the nuances of Kainos’s operating model. It helps companies with digital transformations including implementing AI.
I wonder how much of the potential future revenue will be taken by the AI systems Kainos helps implement over the long term. Large language models have replaced quite a few human services I used to seek out personally. I’m wondering if this trend is going to be negative for Kainos and other smaller tech firms in the future.
I consider it a steal for now
Despite this long-term risk, I think right now, the value opportunity is stark. The price-to-earnings ratio for the shares used to be 40 as a median over the past 10 years. Now, it’s just 28.
I’m not quite ready to pull the trigger on this one. I have other opportunities I’m more convinced of right now. However, this one has made it high up near the top of my watchlist.
