The FTSE 250 is predominantly filled with growth stocks, yet there are plenty of income opportunities as well. And in a few cases, firms can end up being a combination of the two. That certainly seems to be the case when looking at Kainos Group (LSE:KNOS).
The digitalisation and management software enterprise has achieved tremendous growth over the years. And its share price has more than doubled despite the massive tech sell-off in 2022. Yet, over this same period, dividends have been hiked aggressively.
In 2019, shareholders were receiving 9.3p in dividends per share. Today, that figure stands at 27.3p – a 194% increase. And if analyst forecasts prove to be accurate, this payout could be set to rise once again, reaching 28.9p in 2025, followed by 31.5p in 2026.
So what’s driving this success, and should I be adding some Kainos shares to my portfolio right now?
The dividend growth potential
In recent years, Kainos has switched its primary focus from digitalisation services to Workday services and software. By supporting the integration of the Workday platform as well as offering its own custom-built plugins, the firm’s helping businesses become more operationally efficient.
It’s an opportunity for customers to save money in the long run. And given inflation rehighlighted the importance of earnings, Kainos has benefited from this tailwind.
In its most recent trading update, growth’s proven to be a bit challenging lately. Higher interest rates mean customers are delaying projects, causing demand to drop.
However, since the Bank of England’s already begun its rate-cutting programme, that may soon change. And it seems management agrees, given it’s revised its growth targets to be even more ambitious, delivering up to £200m in annualised sales by 2030 for its Workday Products segment. For reference, this figure currently stands close to £60.5m.
With a similar long-term outlook for its other divisions, the growth seen to date may only be the tip of the iceberg. And with higher cash flows comes the potential for even bigger dividends.
What could go wrong?
Kainos’ track record is quite impressive. While it’s at the mercy of budget cycles, its diversification away from being a digitalisation pure-play has helped reduce this sensitivity. And with prudent capital allocation and impressive free cash flow generation, the company continues to be entirely debt-free.
However, it’s far from a risk-free enterprise. Kainos’ long-term fate is now ultimately tied with Workday, one of many human capital management (HCM) platforms.
Right now, this third party software package is used by some of the biggest businesses in the world, including half of the Fortune 500. It’s a critical piece of technology handling recruitment, regulatory compliance, payroll, and financial accounting. However, if Workday can’t maintain and expand its market share, the long-term dividend growth potential of this FTSE 250 stock may be compromised.
The bottom line
With Kainos shares taking a small tumble on the back of the recent short-term weakness, the stock’s valuation’s looking fairly attractive compared to where it normally trades. And with a starting dividend yield of 3.1%, it’s an income opportunity I feel’s worth considering, despite the risks.
