If you are waiting for the shares to become cheap on fundamental terms – earnings multiple, dividend yield, enterprise value (EV) as a proportion of annual underlying earnings (EBITDA) – you are probably going to have a long wait.
For as long as anyone can remember, the shares have been expensive on a “rear-view mirror basis” but if it is proof you are after that stock market valuations are based on future expectations rather than historical perspectives, Halma is exhibit A.
A stratospheric price/earnings ratio
Based on its earnings for the year to the end of March 2020, Halma trades on a price/earnings ratio (PER) of 40.9.
Fellow FTSE 100 engineer, Melrose Industries PLC (LON:MRO), is just about the closest parallel there is to Halma. It has a PER of 24.4, although admittedly its shares (and earnings) have been hammered this year by the tribulations suffered by the aerospace industry; for comparison purposes, Melrose’s PERs for 2018 and 2019 were 12.9 and 11.6, respectively, while Halma’s were 26.0 and 31.7.
So, expect to buy Halma at a daunting PER.
EV/EBITDA? That’s a multiple of 29.3, up from 23.2 last year and 19.6 the year before that.
You can think of EV/EBITDA as a measure of how many years it would take for a purchaser of the company to earn its money back (assuming earnings remained flat). The point with Halma is that, for most of its existence, the earnings have not remained flat.
Dividend yield? A paltry 0.7%, down from 0.9% last year and 1.2% the year before that, despite the company hiking dividends by 5% or more every year for more than four decades.
That’s an achievement not to be sneezed at as a mere handful of FTSE 100 firms (including Croda, Spirax-Sarco, Pennon and Legal & General) have managed to increase their annual dividend every year for at least a decade.
It is clear from those metrics that investors are expecting the company’s remarkable track record to continue, hence the seemingly high valuation.
A safe pair of hands
The company’s management is highly thought of, with a track record of augmenting organic growth with well-judged bolt-on acquisitions.
It’s not exactly a full-blown technology stock but with a focus on sensors in hazard detection and life protection situations, it’s got a bit of tech sizzle while what libertarians might term the whole ‘elf and safety gone mad trend means it operates in constantly expanding markets.
“The mandatory nature of investment in this area creates consistent business flows and sticky customers, a combination which gives Halma a degree of pricing power. That, in turn, can mean high margins, good returns on capital, strong free cash flow and a growing dividend for investors over the long term,” said Russ Mould, the investment director at AJ Bell.
“Halma has proved to be one of the most resilient stocks in the sector and deserves its premium,” said broker Peel Hunt at the time of Halma’s full-year results announcement, back in July.
At that time, the broker rated the stock a “hold” on a PER of 48, based on the broker’s projected earnings per share for fiscal 2021. Maybe a PER of 40.9 is not so daunting, after all.
One for the digital sock drawer
Investors tend not to have share certificates any more but if they did, then this would be a classic share to stick in the sock drawer and forget about.
If you had a modified De Lorean and could travel back to 1979 when the dividend-hiking streak began, Russ Mould reports you could have bought the shares at 1.9p. On that basis, this year’s forecast pay-out of 17.04p looks a lot sexier than the 0.7% dividend yield (on current prices) might suggest.
“While this might seem like an extreme example, it does show how well-run, well-financed companies which build and hone their competitive position can reward truly patient investors, with the ideal combination of capital gains and income. Halma has been able to do this, and keep that dream alive because management continues to get the fundamental basics right,” Mould said.
The AJ Bell investment director suggests that Halma has benefited from a flight to quality during the pandemic and that “any hint of a rapid upturn – due to a vaccine or some other factors – could see such expensive stocks start to lag cyclical names, which have the potential in the short term offer faster growth.”
He’s probably not wrong but history indicates that people who invest in Halma are not looking for faster growth, just a high level of confidence that there will be some growth, year in, year out.