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Kainos shares are rising today: would I buy?

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Shares in IT services firm Kainos Group (LSE: KNOS) are up by 18% as I write on Friday morning. The Kainos share price has now risen by 57% over the last year and by more than 500% over the last five years.

Today’s gains come after the firm said that it now expects profits for the current year to be ahead of market forecasts.

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Strong trading since November

Kainos says that trading has been strong since the company’s last update in November. Both of the company’s divisions are said to be performing well.

The group’s Digital Services business is working on a number of “substantial, long-term” UK government projects relating to digital transformation. The firm is also supporting the NHS as it responds to Covid-19.

Revenue from digital services rose by 16% to £71m during the six months to 30 September. This business now generates about 65% of the group’s revenue, making it the larger of its two divisions.

However, growth appears to be much stronger in the smaller Workday division, which provides consultancy and support for companies using Workday software — a finance, HR, and business planning system.

In its half-year accounts, Kainos said that revenue from Workday rose by 41% to £36m. This momentum appears to have continued during the second half of the year. Today Kainos said it is continuing to win new consulting contracts for Workday, especially in North America.

Kainos shares: is the price right?

Belfast-based IT group Kainos was founded in 1986. The company is now a FTSE 250 member with a market capitalisation of £1.4bn.

I’d like to have more technology exposure in my shares portfolio. Kainos is one of the companies I’ve been considering to satisfy this goal. One attraction of this business for me is that it has quite high profit margins and appears to generate plenty of surplus cash.

Over the last few years, strong profit growth has supported a rapid increase in the Kainos share price. However, the company warned today that both Covid-19 and Brexit are posing some “ongoing challenges”. The firm’s management still believe that Kainos is “well-positioned for further growth”. But I’m worried that if I buy today, I may end up paying too much for this stock.

My personal approach to investing is that I can accept an uncertain outlook if the shares I buy are cheap enough to reflect this uncertainty. Before today’s news, Kainos shares were trading on about 36 times forecast earnings for 2020/21, with a dividend yield of 1.4%.

In my view, this valuation only looks sustainable if growth remains strong. Before deciding to buy, I need to ask myself what might happen if profit growth slowed. In this case, I think the shares could fall sharply to trade on a lower multiple of earnings.

Although I would like to own Kainos shares some day, my decision after today’s news is that I will continue to watch this business. Hopefully, I’ll be able to add Kainos to my portfolio more cheaply in the future.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Workday. The Motley Fool UK has recommended Kainos. 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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