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It is rare to find an investment that has a 12-month average target price indicating growth of 45% based on 10 analysts' reports. Yet that is exactly the current situation with one of the leading UK stocks I know of. Prices (LSE: KNOS).
The strength of this opportunity is largely based on the company's lower earnings growth compared to the past. This has caused a large price drop, leading to what I believe is a significant undervaluation. However, with growth likely to improve in 2025, I believe there are strong returns on the horizon.
Greedy when others are afraid
Investing is a contradictory business. When markets are up, it's not usually the best time to buy stocks. Instead, I want depressed prices on great companies. In other words, as a value investor, I'm looking for a bargain.
The reason this is so important is that at a lower valuation, my gains are likely to be higher, as long as I buy at an inflection point, which is when a company's prospects appear to be about to improve.
Kainos is currently trading at a price-to-earnings (P/E) ratio 41% below its 10-year average. Its earnings per share are expected to grow faster, from an annual average of 8.1% over the past three years to 8.9% over the next three years.
When companies show stronger growth like this, investors typically buy more shares, which can push up the price-to-earnings ratio. This means I could benefit not only from faster earnings growth, but also from a rising valuation.
The dangers of downward momentum
Despite the opportunities this offers, value investing is not always a direct path to riches. Instead, once I buy cheap stocks at a turning point, I often have to endure some losses before (and if) my future gains begin.
It's incredibly difficult to predict market timing. The best value investors don't try to bet on when a company's stock price will stop falling. Instead, they invest in a company's financials and make sure it sells for less than it's likely worth.
Kainos shares are down 55% over the past three years. While I don't think its price will drop much further, I can't guarantee it. Instead, I've assessed the company's future growth prospects and believe that now is the most sensible time to invest in it.
The rewards outweigh the risks
I always work to actively diversify my portfolio to protect myself from the pitfalls of a single investment. By holding 10-15 undervalued companies across geographies and industries, I am well protected from the risks.
However, I am still actively seeking out the best stocks I can find. Based on my research, Kainos is certainly one of the top UK tech investments on the market. Even with the rise of ai and automation capabilities potentially threatening its market position in the long term, I am bullish on the company for now.
It is significantly undervalued, primed for a shift in investor sentiment based on improved growth rates in 2025, and my outlook is supported by a strong analyst price target consensus of 45% growth in just 12 months.
What more could a dumb investor want? I'll probably buy Kainos stock with the next available cash I get my hands on.
