A Top Small-Cap Share

Judges Scientific

Extracting value with a ‘buy and build’ strategy

Credit: Getty Images.

By Malcom Wheatley, Investment Writer, Motley Fool UK.

Dear fellow investor,

Rarely do you stumble across such a high calibre example of a proven small cap business still with plenty of ongoing growth potential. Yet I believe that’s exactly what we could be looking at here with Judges Scientific (LSE: JDG).

About the company

Founded in 2002 by David Cicurel, a specialist in corporate turnarounds, Judges pursues a strategy of buying privately-held companies which manufacture scientific instruments. There are, it turns out, over 2,000 of these in the UK.

It then helps these newly-acquired companies to grow, by leveraging its own capital, guidance and expertise, all under an umbrella of robust financial controls. It calls this approach ‘buy and build’, and as of the last full financial year, to 31 December 2020, some 19 companies have been acquired.

Judges reckons to have a good reputation as an acquirer, being both trusted to honour the pre-acquisition ‘Heads of Terms’ agreed, and trusted to then move quickly with secured funding. It makes a point of treating vendors and staff with respect, and avoids ‘micro-managing’ the companies that it acquires.

Judges also prides itself on being extremely selective, with exacting requirements both in terms of the business that it acquires, and the prices that it will pay for them. In general, the companies must have established reputations in worldwide niche markets, and be generating sustainable profits and cash.

Judges will pay three to six time EBIT for a company, mostly according to its size, and borrow up to 2.5 times EBITDA at a finance cost of 2–4%, depending on the group’s level of borrowings at the time. The approach then is to pay down the debt, and reinvest profits from the acquired businesses in making further acquisitions. The companies being acquired generally aren’t particularly large, with most being bought for less than £5 million.

Investment thesis

Judges is not a complicated businesses. All its subsidiaries operate in broadly comparable markets — scientific instruments — and are of a broadly comparable size. And all the subsidiaries perform broadly comparable tasks: designing equipment, manufacturing it, and selling it.

Its financing seems conservative, the acquisition policy is conservative, and Judges’ policy and practice is to avoid doing anything that would damage its reputation as a successful acquirer and operator of the businesses that it selects.

Any such damage, it is aware, would harm its standing in the eyes of both shareholders and the banks on which it relies for finance, in order to make these acquisitions.

Judges’ board is rightly proud of its record in growing the dividend, with the payout having grown by 19% per annum over the past five years. Judges aims to raise the dividend by over 10% each year, and over the past 15 years has reported a compound annual dividend growth rate of 23%. For what is in effect a collection of small (but specialised) manufacturing companies competing on the global stage, that’s pretty good.

Ten years ago, Judges’ shares were changing hands for 490p or so; these days the price is 6300p. And over the past five years, the share price has risen over fivefold, pushing the P/E ratio up to a heady 34.3 as these words are written.

Financials and valuation

Source: Judges Scientific.

As of 31 December 2020, Judges had net cash on the books of £15.5m, even after making two acquisitions during 2020 — Heath Scientific for £7.3m, and Korvus Technology for £2.6m. That said, the Covid-19 pandemic hadn’t left the business unaffected; order intake dropped as laboratories — especially in universities — were closed, and so revenues and profits were both slightly down on 2019 levels.

Speaking of profits, adjusted operating profit is Judges’ preferred way of reporting profitability to shareholders, which is what is shown in the figures above. Judges’ preference for operating profit as a measure is understandable: because of its acquisitions-driven business model, the more usual pre-tax profits figures show considerable year-to-year distortion due to tax credits and the amortisation of acquired intangible assets.

So is Judges cheap?

In one sense, definitely not: a price-earnings ratio of 34.3 is undeniably demanding, although higher ones are to be seen. But in another sense, the answer is ‘quite possibly’.

Judges is likely to be one of those shares that rarely seems cheap, and yet has motored ahead to provide shareholders with generous share price growth. Waiting for a more favourable price-earnings ratio might not be fruitful — even during the recession of 2008-2009, Judges’ share price proved more resilient than the broader market, and barely budged in the post-referendum market wobble.

The bottom line is that Judges appears priced for further growth.

Risks and when I’d sell

The risks of an investment in Judges aren’t difficult to spot. Judges is a clutch of small specialist design, engineering, and manufacturing companies, selling on the global stage. Currency movements and the health of the broader global economy will obviously impact its fortunes.

Moreover, Judges’ strategy is to keep acquiring more such businesses — and however careful the company’s due diligence, there’s always a chance that a business might not turn out to fulfill Judges’ expectations. So execution risk is very much present.

Helping to mitigate that risk are Judges’ veteran executives and non-executive directors. A lot rests on their judgement and abilities, and to my eyes, chief executive David Cicurel — now in his early seventies — appears particularly crucial, acting as he does as the main point of initial contact for business owners wanting to sell.

Judges isn’t a large business, and succession planning right through the organisation is obviously important.

When would I sell? To date, Judges’ performance has been excellent. And I think that I’d be reasonably tolerant of a single acquisition underperforming, or even turning bad. Even at the upper reaches of the FTSE 100, acquisitions have a patchy record of success, and it is unrealistic to expect Judges not to slip up at some point.

My real worry is Mr Cicurel. Should he depart the business, or retire without retaining a presence on the board, then I’d watch his successor like a hawk.

Looking for more investment ideas?

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As I briefly mentioned above, Mark Rogers and his team of investing experts at Hidden Winners have already twice recommended Judges Scientific shares to members. Keep in mind this is one of the service’s best performers, and is not intended to be representative. Not all of the recommendations have performed so well, and some have fallen in value.

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To your investing,

Malcolm Wheatley
Investment Writer,
Motley Fool UK.

Sources: The Judges Scientific investor website and Judges Scientific’s annual reports 2017–2020.

Disclosure: As of 16 July 2021, Malcolm had a beneficial interest in Judges Scientific.

This free special report was last updated on 30/07/2021. A previous version of this content was published as part our Motley Fool Shares 2020 report in November 2019.