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Investors tend to focus on negatives, rather than positives.
Take, for example, rising interest rates. Although they are acting as a drag on the economy’s growth rate and are suppressing share prices by weakening investor sentiment, they provide an unusually attractive opportunity for high-quality companies to strengthen their market position.
Indeed, while some companies are struggling to grow sales and profitability, others are capitalising on low asset prices to make acquisitions.
Some investors may view this as a risky strategy given the uncertain near-term outlook for the economy amid sticky inflation and ongoing monetary policy tightening.
But in Questor’s view, now is an excellent time for businesses to engage in mergers and acquisitions (M&A) activity due to the likelihood of long-term mean reversion for inflation, economic growth and corporate profitability.
AIM-quoted Judges Scientific’s business model is centred on buying other companies. The designer and producer of scientific instruments made 20 acquisitions between 2005, when it first entered the scientific instrument market, and the end of its 2022 financial year.
Its largest purchase was made last year when it spent up to £80m on Geotek, which specialises in the analysis of geological cores for the mining and hydrocarbon industries.
The purchase had an overwhelmingly positive impact on Judges Scientific’s full-year results, with revenue rising by 24pc and adjusted operating profit up 60pc on the previous year.
Even excluding the impact of recent acquisitions, revenue grew by 8pc. The company also recorded a modest increase in the size of its order book, which shows that it is performing relatively well despite a challenging global economic environment.
It was also able to maintain its adjusted organic operating profit margin at 21pc in spite of inflation. And with return on equity exceeding 26pc last year, as well as an average figure of 32pc being recorded over the past five years, the company appears to have a competitive advantage that bodes well for profitability.
Since the end of its financial year, the company has made two further acquisitions. It would be wholly unsurprising for there to be more purchases over the medium term, with a solid financial position providing the opportunity to grow at a faster pace via M&A activity without taking undue risks.
Indeed, Judges Scientific’s net debt-to-equity ratio stands at 72pc, while its net finance costs were covered over eight times by operating profit last year. These figures suggest it has the means to not only survive a challenging economic period, but to capitalise on the lower asset valuations it has prompted.
The company has exposure to a wide range of international markets. North America and Europe each account for 28pc of its sales, while China/Hong Kong contributes 12pc of revenue.
Although global growth is expected to slow to 2.7pc this year from 3.2pc last year, according to the OECD, it is then forecast to accelerate to 2.9pc in 2024.
With inflation in the US and the eurozone continuing to moderate, further interest rate rises may prove to be somewhat limited. This could have a positive impact on the global economy’s growth prospects, thereby providing stronger operating conditions for the company.
Trading on a price-to-earnings ratio of about 25, the company’s shares are by no means cheap.
However, in Questor’s view, Judges Scientific is a high-quality company with a long track record of sound financial performance that is worthy of its premium valuation.
Its solid balance sheet provides the foundation for further acquisitions to build on its wide economic moat in an era of attractive asset prices. And with an improving operating outlook ahead, it is well-placed to deliver share price growth over the coming years.
While Questor can never guarantee that any stock will ultimately qualify for inheritance tax relief, the company is a new addition to our portfolio.
To make room for Judges Scientific, construction materials supplier Breedon is being removed from our portfolio.
The company’s shares recently moved from AIM to the main market, and are no longer eligible for inheritance tax relief, with a share consolidation on a one-for-five basis completed in tandem. The company was added to our inheritance tax portfolio in July last year and has generated a small gain.
Questor says: buy
Ticker: JDG
Share price at close: £92.20
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