Owning shares in software provider Kainos (LSE: KNOS) has been lucrative over the past five years. During that period, the Kainos share price has more than tripled.
With continued momentum in the business, could investing at today’s share price and holding the shares for the coming 10 years be a rewarding choice for me?
Powerful performance
The company issued a trading statement today (31 August) in which it affirmed consensus market expectations for its performance in its current financial year.
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Those forecasts anticipate revenues in the range of £418m-£434m and adjusted profit before tax of £73m-£78m.
While the company referred to an “uncertain trading environment” in the statement, it said customers are continuing to spend on digital projects.
It would mean that, over a five-year period, Kainos will have achieved compound annual revenue growth of around 23%. Adjusted profit before tax during the period will show a compound annual growth of around 27%, if the company delivers on its forecast.
Bright outlook
That sort of growth is the stuff of many investors’ dreams. It helps to explain why the Kainos share price has rocketed over the past five years.
I think the business benefits from a number of factors that will continue to work to its advantage and could help fuel further growth. Those include ongoing high demand for large-scale digital transformation projects, Kainos’s sizeable existing customer base and a growing global footprint.
Set against this though, I do see some risks. The company’s acknowledgement of the current uncertain trading situation is one of them. If companies rein in spending due to a tough trading investment, they could seek to scrap or delay digital projects.
Another potential weakness – but also a possible strength – is the software company’s close relationship with enterprise management platform Workday. One risk I see is that Workday’s significance to Kainos’ revenues could mean it tries to squeeze bigger financial returns from the relationship in future.
Valuation
Even considering those risks however, I remain upbeat about the long-term outlook for Kainos.
Its track record has proven its ability to innovate, scale and grow at speed. I think it can keep growing and expect profits a decade from now to be substantially higher than now.
However, I also think the current Kainos share price fully factors in that potential. With a market capitalisation of around £1.5bn, the company is trading on a price-to-earnings ratio of around 37.
If anything, that looks expensive to me, even for a company with promising growth prospects. Indeed, the Kainos share price has fallen by around a 10th over the past year, despite strong commercial performance.
For the shares to have a golden decade from that starting price, I think the business will need to accelerate its already high growth rate. That can be challenging to do as a company grows.
Given those valuation concerns, I will not be adding this UK tech stock to my portfolio at the moment.
