Recently, I’ve been sifting the FTSE 250 to find the cheapest shares with the most growth potential. Sure, leading FTSE 100 stocks like Lloyds dominate the headlines but that doesn’t mean they deliver the best returns.
The FTSE 250 index expands on the FTSE 100 by listing the next 250 most valuable companies below the top 100. It’s a lot more to dig through and even lists some companies I’ve never heard of, which is often where the gems hide.
With enough digging, I occasionally find shares with lots of potential selling at a discount. And I think I’ve found one worth buying.
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An undervalued FTSE 250 gem
Kainos (LSE:KNOS) is a £1.4bn digital technology services provider to organisations around the world. One of its main services is the deployment and support of Workday, a popular business management tool that simplifies day-to-day operations.
Kainos shares are down 22.5% over the past year, now trading at £11.20. The shares reached £17.60 in late 2022 before steadily declining for the following 12 months. Only recently have they begun to show signs of a promising recovery.
The share price recently broke above a trend line that has been holding the price back since late 2022 (illustrated in the graph below). Soon after, it broke above its 200-day moving average for the first time since July last year.
I think this is a strong sign that investors are showing renewed interest in Kainos.
Brokers are also onboard. Berenberg recently reinitiated its coverage of Kainos, putting it at a ‘buy’ with a price target of £13.15. Elsewhere, analysts envision of price of target of £12.42 on average. With a clean balance sheet and no debt, the company’s future return on equity (ROE) is calculated to reach over 40% in the coming three years.
Concerns to consider
Naturally, some issues could be of concern to me. For instance, there was a recent insider sale of £509k worth of shares by a Kainos divisional director. Or the fact that the company’s CEO of 22 years, Brendan Mooney, recently stepped down. During his tenure, he led the firm through a successful IPO and brought it to international success. Hopefully, his replacement can keep up the good work.
The company also has a lower-than-average dividend yield of only 2.2% and payments have been volatile. There has been some talk of dividends increasing but not by enough for it to be considered a valuable dividend stock anytime soon.
A focus on AI
For me, a driving factor that I believe will push the Kainos share price higher is its continued interest in artificial intelligence (AI). Kainos already has a well-established AI division but more recently made a decisive £10m investment into the development of generative AI.
The UK is considered to have the third-largest AI industry in the world behind the US and China. Kainos is rapidly revealing itself to be a potentially big player in this breakout industry. If its investment into AI pays off, I believe it will validate analyst estimates that consider it to be undervalued by 36%.
