Two lucky investors woke up as millionaires yesterday when the winning numbers of the NS&I Premium Bonds monthly jackpot were announced. While both winners are now entitled to the exact same amount, £1m, but the disparity in their profiles highlights a fundamental flaw with the Premium Bond scheme.
One of the winners in October’s draw had maximised her allowance of £50,000 two years ago. Meanwhile, the other winner had invested just £4,000 20 years ago. The fact that both have now won the exact same amount suggests that luck, rather than patience or strategy or discipline, is the key to success with Premium Bonds.
How lucky do I have to be to win? According to my Fool colleague Edward Sheldon, the odds of winning anything at all are one in 24,000, while the odds for winning the jackpot are 41bn-1 for each bond purchased.
I don’t like those odds and I don’t like the fact that my money could be sitting around for decades without a regular and predictable income in the hope of winning a jackpot someday. Instead, I’d settle for investing in a company that has a predictable income stream, high return on equity and a competitive advantage.
If the company I pick can compound its value at an annualised rate of 26% or above, I can turn a £100,000 investment into £1m in less than a decade. Here’s a stock that can demonstrate how practical this plan could be.
Kainos
Enterprise software provider Kainos Group (LSE:KNOS) is the sort of stable growth company I like to focus on. The firm develops and delivers a platform that helps government agencies and private businesses manage their human resources and finances through an integrated portal.
This type of service tends to lock the customer in once the business’s core operations have been deeply interlinked with the platform. Meanwhile, the cost of acquiring new customers and getting them to keep renewing their subscription is relatively lower than creating the platform in the first place, which makes Kainos’s business model incredibly lucrative.
According to its latest report, the company’s pre-tax margin is 15.4%, while sales and profits have grown at annualised rates of 26% and 27% respectively since 2013. The company expects double-digit growth to continue for the foreseeable future.
The stock was up 388% between 2015 and June 2019, while consensus analyst estimates are calling for revenues to grow 55% to £150m over the course of 2019. In short, Kainos’s expected growth and track record meet my 26% hurdle for a ten-fold return in less than a decade.
This growth seems to be powered by the company’s aggressive investments in constantly upgrading the platform and acquiring more clients overseas. Despite this pace of reinvestment, management thinks there’s cash to spare as the stock currently offers a 2% dividend yield.
Foolish takeaway
In my opinion, picking a company with stable and gradually appreciating cash flows like Kainos is better than investing in Premium Bonds and waiting decades for an uncertain pay-off. I think the opportunity costs and inflation costs of Premium Bonds are far greater than the potential risks of investing in robust software businesses.