I have had my eye on software company Kainos (LSE: KNOS) for a while. I like its government contracts and strong position helping companies use Workday software. So why have I held back on buying Kainos shares? I simply did not feel the price was attractive. Other investors clearly liked the business too and had pushed the share price up accordingly.
But after Kainos shares fell a fifth yesterday (13 November), they are now 42% down from their 12-month high. Does that finally offer me the sort of buying opportunity I have been waiting for?
Looking under the bonnet
The first thing to when a share falls a fifth in one day, let alone over 40% in under 12 months, is to look for possible explanations.
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Yesterday’s fall followed the release of interim results that went down like a lead balloon.
But overall, they seemed pretty good to me. Revenues were 7% higher than the prior year period, while pre-tax profit grew 12%. The interim dividend was lifted 5%.
One element that concerned investors was a 9% fall in bookings.
So, while the company maintained an upbeat tone about its financial outlook, the reality is that the contracts finalised during the first half were collectively worth 9% less than in the prior year.
That could suggest the company is starting to feel the impact of clients tightening their belts, or postponing non-critical IT spend.
Valuing Kainos
As a long-term investor, I do not pay much attention to short-term price movements.
Instead, like famous investor Warren Buffett, I aim to buy into a company if I think its long-term value is substantially greater than its current share price.
Even after the fall in Kainos shares, the Belfast-based software specialist trades on a price-to-earnings (P/E) ratio of 29.
Admittedly that is lower than software giant Microsoft and its P/E ratio of 36, but Kainos is a much smaller, less proven business than Microsoft. I think 36 is too high for any business, but I also think 29 remains too high for Kainos.
After all, it continues to grow at a fair clip but not a stellar one. The sort of valuation it currently commands suggests a business with exceptionally strong growth prospects.
I do not see Kainos’s current growth in that way — and the decline in bookings suggests things might be heading in the wrong direction.
Buy now or wait?
Every business has its fair price. As an investor, I think it is important to pay at or below that price, not above it.
Kainos is solidly profitable, has a cash pile of £113m, a large installed user base and is the leading pan-European Workday consulting specialist. Those are all strengths that mean I would happily add it to my portfolio at the right price.
For now, though, I continue to see the shares as overvalued. So I have no plans to buy just yet. I will keep on waiting, as I have for years.
