MARKET COMMENT
The Strongest Dividend On The Market

By James Carlisle
December 3, 2002

You can tell a lot about a company by the nature of its disappointments and the 'disappointment' coming out of Halma (LSE: HLMA) this morning is that it has reduced its rate of dividend growth again. There's nothing surprising about that in the current market, but the exact numbers are unusual. This year's interim dividend will be 'just' 10% higher than last year's. For 2000 and 2001, the dividend had grown at 15% and, for the 20 years before that, the dividend had been raised by 20% per year (or more).

If you add a dividend yield of a few per cent to these rates of growth, then you get total returns of something over 20% per year, which is up at the Warren Buffett end of the performance scale. But these returns have been made in exceptional times, with inflation often up towards the 10% mark and occasionally even higher. Looking forward, growth and returns should be a fair bit lower (but just as valuable in real terms because of the low inflation), as Buffett himself has been at pains to point out.

For several years now, Halma has persisted in growing its dividend at a higher rate than its projected growth, because it hasn't seen the opportunities to invest its growing cash pile. The dividend is a very efficient means of handing surplus cash back to shareholders (it has also been buying back shares), and it's a shareholder-friendly policy, but it has seen dividend cover fall to a relatively thin 1.7 times.

Following the €72m acquisition of BEA Group in October, Halma has now moved into a small net debt position for the first time in a while. So the response, quite rightly, is to move to a more conservative dividend policy. Growth in profits over the last 10 years has been around 9% per year. Over the more difficult past three years, this has fallen to just 5%, but the generation of free cash has continued to move along at 8% thanks to the low capital requirements of Halma's businesses. If we hope for a recovery to come along in due course, then 10% seems like a good figure to be going along with.

The remarkable thing is that many companies would have been delighted to trot along at this rate during the inflationary 70's and 80's. In the current environment, the emphasis seems to be about just maintaining dividends. Compared to this, Halma is still racing along.

It might not have the greatest dividend cover and it might have a small net debt position, but those aren't the only factors underpinning long-term dividend strength. What you're looking for is a dividend that can grow comfortably ahead of average wages (currently about 4.5% per year), and for that you need long-term growth in cash earnings. That's where Halma has shined in the past and there's no reason for that to change now.

So, what I want to know is this. If Halma doesn't have the strongest dividend on the stock market, then who does? Because, quite frankly, I'll be interested in purchasing some shares. If you know of any candidates, then let me know on the discussion boards.