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Why it might pay to back Kainos even if it looks expensive

Mon 10:55am by Jack Brumby

There's an elite group of stocks that most investors would love to own. These companies have stellar track records, sparkling reputations and the ability to deliver stunning returns over long periods - and Kainos (LON:KNOS) is a good example.

What makes stocks like Kainos so appealing is their strong exposure to the proven return drivers of high quality and momentum. It makes them capable of compounding market-beating returns over many years.

The catch is that they often come with pricey valuations - but what looks expensive now can sometimes look cheap in hindsight.

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You can think of these shares as being the stock market's High Flyers. So what are the common features of stocks like Kainos and where can you find more companies that have them?

GET MORE DATA-DRIVEN INSIGHTS INTO LON:KNOS »

High Flyers are high quality...

To start with, High Flyers are very distinctive. They are good quality, both in terms of their franchise and financial strength. This tends to show up in high profitability and strong industry leading margins. They’re stable, growing and often have accelerating sales and earnings. They also have strong and improving financial histories and no signs of accountancy or bankruptcy risk.

Kainos is a mid cap stock in the IT Services & Consulting industry. One of its stand out quality metrics is its 5-year Return on Capital Employed, which is a solid 45.7%. Good, double-digit ROCEs are a pointer to companies that can grow very profitably.

...and they have powerful momentum...

High Flyers also have strong momentum both in the price of their shares and their track records of earnings growth. It shows up in stocks trading close to their 52 week high prices and outperforming the market. They’ll often be beating broker estimates and getting forecast upgrades and recommendation changes.

This is true at Kainos, where the share price has risen by % over the past five years. This positive momentum has continued over the past year - Kainos's 1-year relative price strength is 48.9%. This kind of momentum can be a powerful factor and often persists when the shares look expensive.

... but they can be expensive

The drawback with high quality, strong momentum shares is that the market loves these traits. So stocks like Kainos rarely look cheap, and that can put many investors off. Only with hindsight could you say they were a bargain.

Stockopedia's ValueRank scores stocks using a blend of the most important value ratios - from 0 (expensive) to 100 (cheap). On this basis, Kainos has a ValueRank of 12 - putting it squarely in the most expensive third of the market, even though its share price has been fairly flat over the past year.

Overall, the High Flyer approach is appealing because it targets the best quality, strongest momentum shares in the market. That combination of factors can zero-in on the type of company that’s capable of compounding investment returns over many, many years.

If you can catch them at slightly less expensive valuations - perhaps when the market is distracted - then all the better.

Find the rockstars of the stock market

High Flyers are great stocks to have in your portfolio if you think you need more momentum or quality - just look out for signs that momentum might be changing. If you want to see which other stocks qualify as High Flyers, you can find a comprehensive list on Stockopedia's StockRanks page.

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