Image source: Getty Images
It’s rare to find an investment that has a 12-month average price target indicating 45% growth based on reports from 10 analysts. However, that’s exactly the situation right now with one of the top UK stocks I know, Kainos (LSE:KNOS).
The strength of this opportunity largely rests on the company’s lower earnings growth compared to historically. This has opened up a big price decline, which has led to what I think is a significant undervaluation. However, with growth likely to improve in 2025, I think big returns are on the horizon.
Greedy when others are fearful
Investing is a counterintuitive business. When the markets are roaring, that’s often not the best time for me to buy shares. Instead, I want depressed prices in great companies. In other words, as a value investor, I’m looking for a bargain.
The reason why this is so important is that with a lower valuation, my returns are likely to be higher. That’s as long as I buy in at an inflection point, which is when a business’s prospects look like they are about to improve.
Kainos is currently trading at a price-to-earnings (P/E) ratio that’s 41% lower than its 10-year median. 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 often buy more shares, which can push the P/E ratio higher. This means I could benefit not just from faster earnings growth but also from a rising valuation.
The perils of downward momentum
Despite the opportunity here, value investing isn’t always a straight path to riches. Instead, once I buy cheap shares at an inflection point, I often have to weather some losses before (and if) my future gains begin.
It’s incredibly hard to time the market. The greatest value investors don’t try to bet on when a company’s share price will stop falling. Instead, they invest in the financials of a company and make sure it is selling for less than what it’s likely worth.
Kainos shares are down 55% over the past three years. While I don’t think they will fall much further in price, I can’t guarantee that. Instead, I’ve assessed the company’s future growth prospects, and I believe now makes the most sense for me to invest in it.
The rewards outweigh the risks
I always work to actively diversify my portfolio to protect myself from any drawbacks of a single investment. By holding 10 to 15 undervalued businesses from varying geographies and industries, I’m well protected from risks.
However, I still actively look for the best shares I can find. Based on my research, Kainos is certainly one of the top UK technology investments on the market. Even with rising AI and automation capabilities potentially threatening its long-term market position, I’m bullish on the company for now.
It’s significantly undervalued, primed for changing sentiment from investors based on better growth rates in 2025, and my outlook is supported by a strong consensus analyst price target of 45% growth in just 12 months.
What more can a Foolish investor want? I’m likely buying Kainos shares with the next disposable cash I get my hands on.
