The Halma (LSE:HLMA) share price has taken a step back after the company’s trading update this morning (21 September). But the stock has been one of the best performers in the FTSE 100 over the last decade.
At a price-to-earnings ratio of 33, the stock doesn’t look like an obvious bargain. But I think this is a possible buying opportunity for long-term investors.
Trading update
In general, the latest report was steady, rather than spectacular. Management said it expects to meet the targets it outlined back in June – in other words, things are broadly on track for the business.
So why is the stock down? I think the answer has to do with the company’s M&A activity.
Over the last five years, Halma has managed to increase its revenue by around 9% per year on average. And a P/E ratio of 33 implies that investors are expecting further growth going forward.
A lot of this has been the product of acquiring other businesses. This means it’s important that the company has a good pipeline of future deals to keep growing.
While management reported optimism, M&A activity has slowed a bit this year. Over the last six months, the company managed three deals for £80m, compared to seven deals for £397m through all of last year.
That means the pace of acquisitions is slower than last year. And that’s something for investors to be aware of, since the biggest risk with the stock is that the company can’t find enough deals to justify its market cap.
Business prospects
Yet I think Halma shares could be a great buy at today’s prices. It’s no accident that the stock has provided investors with a 260% return over the last decade.
With a business that aims to grow by acquisition, it’s likely that this will be higher in some years than others. And being disciplined about only doing deals when they’re priced attractively is important.
The company has some durable advantages that I think will achieve results over time. Chief among these is focusing on buying businesses that are difficult to disrupt.
This allows Halma to generate impressive returns on invested capital and strong cash conversion. These are important metrics that help drive shareholder returns.
The business has £223m in fixed assets and generates £308m in pre-tax profits – a 138% return. And around 70% of that operating income becomes free cash available to shareholders.
Both of these are impressive metrics that speak to the quality of Halma’s business. This explains why the stock has been one of the FTSE 100’s top performers.
A stock to buy?
If I had cash to invest, I’d look to buy Halma shares at today’s prices. The path forward is unlikely to be smooth, but it is likely to be impressive.
Even the best companies face headwinds occasionally. And I see this as an opportunity to buy the stock while the market is pessimistic about its prospects.
