Judges Scientific: A Textbook on Value Creation

Disclosure: I have an interest in Judges Scientific shares



Judges Scientific – in your author’s humble opinion – is one of the best companies on AIM. How do we define ‘best’?

Here’s the share price performance over the last 10 years, overlayed with the normalised diluted earnings-per-share. The first measure shows how the market perceives the company. The second shows their delivery in growing shareholder wealth in a more tangible way.


As the caption at the bottom shows you, Judges has a phenomenal track record. I spend most of my waking hours looking for companies that compound wealth in this way, and I don’t find many. Assuming that the history of the company has whetted your appetite, we’ll go a step deeper.


To start with what Judges isn’t: Judges is often described as a ‘roll-up’ company, but to do so tars them with a brush which I think is a little unfair. Roll-up strategies typically entail a player consolidating a fragmented industry by buying a number of competitors and trying to extract synergies from the scale that you derive this way. Judges does not do this. Judges is more like an investment company a la Berkshire Hathaway. The Judges Scientific entity itself acquires small scientific instrument companies and then allows them to run independently. The corporate level acts more as a capital allocator, a unified market entity and a provider of financing than anything else.

What Judges is, is a home for small, monopolistic, high-return scientific instruments companies. There are lots of these in the UK, predominantly because the UK is a world leader in research institutions – Oxford and Cambridge to name but two. These attract world class scientists, and world class scientists or engineers often find themselves setting up businesses catering to the niche in which they are qualified. After 20 years of running these businesses, entrepreneurs need an exit. A stock market listing is not a viable option – they are sub-scale, on their own – and private equity find them either too small or too esoteric. In steps Judges Scientific.

Their model (detailed in their corporate presentation, freely available on their website) is to identify the most resilient of these businesses – typically with a very high percentage  of sales exported, and with few or no competitors – and pay 3 – 6 times EBIT for them. This provides an attractive exit for the entrepreneur and an attractive price for the company. They finance the deal with a slug of debt – 2.5x EBITDA is their stated cap, which practically works out at between a third and a half of the acquisition cost – and the process repeats itself. Today, Judges has ten subsidiaries, though one of them mostly works as a service provider to the rest of the group.

The execution of a strategy like this relies on competent and honest management who are able both to accurately appraise the value of the small companies they come across and then buy them at a price which works both for shareholders and for the seller. We have a few data points on this:

  • The track record of the company is the most obvious one; their competence is  evidenced by their success thus far.
  • The management team – CEO, FD and Chairman – remained exactly the same from 2005 to this year, when the FD retired and Brad Ormsby was brought in.
  • The salaries the board takes are very low for a listed company of its size – £546k total remuneration for the entire board for a £100m market cap company. David Cicurel, the CEO, didn’t take a salary for much of the company’s early history.
  • Depending on how you want to define it, the board and family/friends own 20%+ of the outstanding share capital.
  • The recent acquisition of Armfield is also telling, because it was partly settled in shares. Judges pride themselves on honouring the heads of terms they sign for acquisitions, and not nickel-and-diming as is often accused of private equity buyers. This might explain the reciprocity that we see when Armfield agreed to be paid in shares at a price of 2055p per share (the price when the HoT was signed) – 25% higher than the price of the shares when the deal actually completed.

Having met management, I also appreciate their focus on return on investment, because it is exactly what drives a business like Judges – they are keyed into the right things, understand what drives their performance, and repeat their mantra with zeal.

The businesses

When I think about Judges, I think about it in the framework of buying two assets. I am buying the existing businesses as they stand today, and I am buying the corporate entity and management’s track record of creating value through acquisitions. The sceptic would say that the first of those is what really accrues to shareholders, because the second is both unpredictable and subject to more unknowable risk. The management team could pack up and head to Barbados tomorrow. I’ve outlined in the section above why I think that isn’t likely to be the case, but prudence is a sensible approach.

So let’s look at, and think about the value of, the underlying businesses in the Judges family. To pick out three as examples for flavour:

Sircal Instruments make purifiers for Argon and other noble gasses. High level purity argon is needed for arc spark spectrometry, which is used for analysing the composition and purity metal of samples for steel mills, dealers and so on. A chunk of the business’s revenue comes from consumables. On acquisition, the business was earning 40%+ EBIT margins.

Fire Testing Technology creates instruments which you can use, basically, to test the flammability of objects under certain scenarios. The level of heat generated, the pace at which fire will spread and the quantity and composition of smoke can be measured.

Armfield is the company’s most recent acquisition. Three quarters of its revenue comes from the education sector, with the rest coming from industrial R&D machines. Products include a rainfall simulator (used to measure soil erosion, among other things) a series of what can only be described as ‘engines in perspex boxes’, and some much bigger kit – including a large tunnel which can measure how water will flow and affect silt beds.

There are two observations one can draw from looking at their businesses. The first is that they are predominantly public sector led, by either research or education. The second is that they are very niche, which probably goes some way to explaining their extremely high EBIT margins. The subsidiaries seem to have grown revenues at a high single-digit rate upon subsumption into the broader group, which doesn’t hugely surprise me. The broad categories of testing, measurement and analysis seem likely to be growth sectors in the world generally.

On aggregate the businesses Judges has acquired, as of last FY figures, required a total of £26m of tangible capital to run – if you include the entirety of the cash balance – to produce £7m of EBITA. The flow-through to equity cash flow should be helped by the tax benefits of significant amounts of amortisable intangible assets (customer relationships, trademarks etc.) that the accountants ascribe to the businesses upon acquisition. This is an exceptional return on tangible assets, and I suspect understates the return on incremental capital in these businesses. I suspect future growth will require very little additional investment beyond a splash of working capital and the occasional increase in capacity, as recently occurred.

Around 20% of the group’s revenue is earned in the UK. 80% is exported – 30% represented by Europe, 20% by the US/Canada, and 30% by the rest of the world.

Recent trading

Of course, it’s not all a rose garden, or we wouldn’t be here. After an unblemished 8-year track record of increasing returns and EPS, last year broke the trend. Softness in order intake flowed through to weakening revenue and earnings, and the timing – coinciding with the year following the completion of their largest ever acquisition and adverse exchange rate effects – fuelled some speculation that their model was simply too difficult to scale.

I think one should expect some noise in sales, particularly public sector sales. I also think that – if you believe they are fairly leveraged to public sector spending – now is certainly not a cyclically strong point for their end-markets. Some comfort can be gleaned from the fact that the sales declines were not limited to one geography or one division of the business – which might have led to the conclusion that one of their businesses had a structural issue.

In aggregate, the combined effect of this softness was reducing 2013’s pro-forma EBIT (after adjusting for the timing of acquisitions) from ~£8.6m to ~£7m in 2014. Once you then add in the Armfield acquisition completed early this year, adding ~£2m of PBT, you get to a run-rate PBT figure of around £9m, down from a £10.6m peak.

You can have a discussion about which figure you want to apply a multiple to. Perhaps you think the currently implied £9m run-rate is still too high, and further weakness is in the works. Perhaps you think the currently implied £9m is too low, and we’re at a cyclical low point for spending on testing equipment. I don’t have a huge amount of confidence in either argument. Regardless, given the high-quality nature of the businesses, the exceptional incremental returns on capital, the geographical diversification and the underlying growth trends, I don’t think 14x would be at all an expensive multiple to pay.

Even on the lower £9m figure, they trade cheaper – and their peers, for what its worth, trade punchier than this:

Judges Multiple

At 12x EBIT, I think Judges is a very high quality business at a very undemanding valuation. I think this is a poor way of valuing the business, but it gives us a reasonable baseline – if I assume that the business is worth 14x for all the characteristics I described above, we have another ~15% fall in run-rate EBIT the stock  can absorb before it becomes expensive. And, again, I think you have to make some pretty bearish assumptions to slap on a 20% fall in earnings, and then an additional 15%, and call that the ‘run-rate’ – unless, of course, you believe the market was for some reason structurally over-inflated in 2013 and prior.

My valuation

Point-in-time multiples fail to capture the value creation in a business which is reliant on investing increasing amounts of capital at a high rate of return, and so I use the above methodology as a fall-back sanity check, and not as my determination of what the company is actually worth. For that, you need to think about more things. You can condense it down into 4 key metrics:

  • The rate of return in the existing businesses
  • The amount of growth in the existing businesses
  • The rate of return on acquisitions
  • The amount of capital the management team can deploy on acquisitions

There is an intuitive way of thinking about why the amount of capital deployed makes such a different to the valuation; simply consider that if Judges acquires £1.5m of EBIT for 4x (£6m) and rolls it into a larger group structure trading at 14x (£21m), the group as a whole is worth £15m more. Some people have a gut-led suspicion of this voodoo, and I empathise with that viewpoint – we have all seen plenty of businesses executing roll-up strategies which fail to show any return for shareholders. The difference is that Judges have a track record of already doing exactly that, easily measurable by simply the incremental capital they’ve put into the business and the resulting increase in EBITA, and that they have a strategy which credibly explains why they’re able to add that value. If it helps, you can compare the way Judges creates wealth to the very way I’m trying to by investing in Judges – I am identifying and purchasing assets at a lower multiple than their fair value to the enlarged group.

With that aside, a very simplified version of that model looks this:

Judges model

This one leaves out modelling the effect on net debt (beyond seeing that it is perfectly feasible, which it is). Food for thought on the scenario outlined above includes:

  • Using £7m as the baseline EBIT figure for the core business ex-Armfield. If you believe last year’s slowdown was a cyclical low, this is too harsh.
  • Assuming £10m of annual acquisition spending. The future will be more lumpy than this. The group has already spent £10m so far this year, spent none last year, and spent £12m the year before that. The group has a significant amount of financing capacity at the moment, which grows with its EBIT-base.
  • Assuming a 20% rate of return on investment spending, which equates to a 5x EBIT multiple. Historically, the group has acquired cheaper than this as a weighted average. One might expect it to be dragged higher with larger deals, though, perhaps even beyond 6x (16.7%).
  • The effect of debt and the increase in equity returns is ignored here
  • The 4% rate of growth assumed, arguably from a low base, in a group which historically tracked at mid-high single digits.

If you’re interested in Judges, I think it’s incredibly enlightening to make a model and play around with the assumptions therein. I am slower than most, so it takes modelling scenarios to really get to grips with how and what will really drive the business.

For what it’s worth, using assumptions I think are realistic but neither particularly aggressive or conservative, I think Judges can get to £40 a share within 4 years. The tail-end of that CAGR would give a ~24% return on my investment, as well as a percentage point or two of dividends annually.

And for those who don’t like all of the hypothesising above, think about it this way; you’re investing, alongside management, at ~11x EBIT, in a team with one of the best records of value creation on the London stock market.

I see it as an asymmetric bet; you’re buying a collection of underlying business with above market growth, above market returns and exceptional margins at a cyclically undemanding point. A mini – but better – Oxford Instruments – at a much cheaper multiple. This protects the downside of your distribution. The up case comes if management continue to create ongoing value from accretive acquisitions. Given everything I’ve said so far, I think the skew on this distribution is heavily in investors’ favour.

20 Replies to “Judges Scientific: A Textbook on Value Creation”

  1. Martin

    Lewis, interesting company.

    Do you know why they pay a dividend? Better to reinvest imho.

    One negative point:
    The company trades SEAQ, which I have bad experience with due to intransparency. In the past there were orders for others filled below my bid.

    • Lewis


      Functionally, I don’t think the availability of capital is the biggest impediment to the company’s acquisition strategy. They have substantial gross cash, and management have no problem leveraging a little to increase returns to equity holders, so their total capacity from this point is substantial. Given their extremely high hurdle rates for cheapness/quality with respect to new investments, and the fact that both cash generation and debt capacity scale with the group’s increasing size, it seems likely that deal sourcing and not cash is the barrier to growth here.

      With that in mind, paying a dividend is clearly better than keeping it on balance sheet. That sounds like a neat explanation, but I suspect it’s also to do with the fact that the CEO takes home a bigger dividend cheque than salary, and also simply as a signal of intent and their attitude toward shareholders.

      I agree with you on SEAQ. For readers who don’t know what SEAQ is, it is a trading system used by the London Stock Exchange. Most of us – or at least, speaking for myself – assume that trading on stocks is all done through open order books – whereby everyone who wants to buy posts a bid, everyone who wants to sell post an ask, and then the orderbook matches things up nicely and everyone can see what’s what. SEAQ isn’t like this. SEAQ means that all participants have to transact through market makers in the stock. Ostensibly they’re required to provide liquidity at all times, hence why you can’t undercut them and all transactions must go through them.

      I might ask the company, actually. I would guess that the relatively illiquidity of the stock precludes them from moving to an order-book driven system.

  2. Mark Simpson


    While I agree that Judges is a great company with a good management team who are good capital allocators there are a couple of aspects of your valuation methodolgy that don’t sit quite right with me:

    – You say that judges should be viewed as a investment company but you then value it as a trading company. As you know investment companies are valued in relation to NAV or BV not EBITDA multiples. Berkshire Hathaway uses growth in BV as it’s investment success metric and investors apply a premium to that to reflect hidden assets and future capital investment opportunities. Judges trades at 5xBV and 19xTBV according to Stockopedia (I’ve not checked the accounts directly recently) which suggest a high premium for an investment company.

    – I think the idea that a business bought at a fair price of 3-5xEBITDA is now worth 14 x EBITDA in the group structure because of Judges are great capital allocators misses what EBITDA multiples are – a quick way of doing a DCF under some steady state assumptions. In this case as well you are comparing a real cash payment out vs a market valuation. If there was a market crash tomorrow and becasue of illiquidity Judges fell 50% to 7xEBITDA instead of 14x would the team suddenly be much worse capital allocators? Of course not, so the current market valuation says nothing about how the current subsiduaries or future acquisitions should be valued in the group structure.

    Also I believe it is wrong to argue that the cashflows that the acquired business are worth signficantly more in the hands of the great capital allocators. That misses that real cash has been paid out for that stream of earnings. If Judges bought banking preference shares are they suddenly worth more because Judges will be great at allocating those dividends? I don’t think so. It’s much more obvious when you consider the analogy of listed securities in an investment fund. No one pays a 200% premium to NAV even for the greatest of investors. Unlisted is a little different but not multiples differnt.

    So if we exclude the illogical ideas that the businesses that Judges buy are suddenly worth more because Judges has a certain market rating or that they are good capital allocators and come back the the underlying concept that they are paying cash now for a stream of future cash then we can consider the real factors that mean the acquisitions are worth more when owned by Judges than their private owners:

    1. That there are high organic investment opportunities in the existing businesses that require a small amount of incremental capital and were capital constrained in their previous structure. There may be some of this but companies that are very niche often have their growth constrained by the market not access to capital. It’s no good finding a company with great historical ROCE if there is no scope to deploy extra capital.

    2. the group structure cuts costs – while there may be some central functions that can be consolidated Judges specifically say they don’t do this to any real extent. It helps them do the deal they want becasue owners want their business in good hands but it does restrict their ability to maximise the value of existing businesses. There is also a cost of the Judges management which would reduce net margins if it were pro-rataed across the subsiduaries as a negative factor so this is probably neutral over all.

    3. Increased markets due to cross selling, marketing ability. This seems to be a small factor to me given the diverse niche businesses.

    4. The Discount Factor is lower for Judges. Reasons for this:

    a) Owners have a differnt value of time. This can be particularly acute with an owner coming up to retirement who may value the certainty of cash now much more highly than a more risky future income stream.

    b) Greater stability of cashflows, lower risk. Certainly true for the whole group but note that this only works for sub-listing scale businesses. Conglomerates are out of favour because portolio managment of individual equities can give you the same or better risk structure without the central costs of a combined entity. You can’t count on this as the acquisitions increase in scale.

    c) better capital structure, easier access to debt.

    5. Behavioural bias amongst sellers or decision making on not just purely financial metrics. e.g.wanting business in ‘good hands’. This is one of Warren Buffett’s competitive advantages, people will sell him a business for less than it’s worth because they trust him.

    Of these I think 4a) and 5) are probably have the most impact and it is right to consider these businesses as being worth more when owned by Judges I just I think you have a hard time arguing that these business are both bought at a fair price and stream of future cashflows that these businesses represent are worth 3x as much the day they are owned by Judges.

    I think what you have done with this post and model is great work. Just if you want to use it as a vauation tool complete it as a DFC of excess capital that can be returned to shareholders when Judges starts to run out of material acquisitions that can be made at the right price rather than using EBITDA multiples as a valuation shortcut. Or if you must use a terminal multiple, choose a more conservative one akin the the average purchase multiple plus a small premium not the current 14x which alreay discounts high acquisition led growth at low multiples.


    • Lewis


      Great comments, and thanks for stimulating the discussion.

      To be fair, I agree with the majority of your points. I’ll rattle through a few objections, or counter-points, and then I’ll finish by suggesting where I think the crux of our difference lies.

      With regard to valuing on a price-to-book basis; this is much more feasible when the investment company you’re managing marks its assets to market or, at least, a big chunk of them, as Berkshire does. If I ran a fund that only held Judges shares, and my fund traded at the value of those shares, my fund would be trading at ‘book value’. But Judges itself isn’t trading at book value, because we get the ‘look-through’ of the assets underlying the subsidiary businesses. If we were to adjust Berkshire’s book value to account for the ‘look-through’ effect of it being a holding company, I suspect – though haven’t checked – that we’d see the same thing… though given the big insurance exposure, maybe not. Book value, in my opinion, is a pretty limp proxy in Judges’ case for what we really care about – cashflows to equity holders.

      I’m with you regarding your point on EBITDA multiples and the ‘phantom uplift’. The valuation attached to Judges shares has nothing to do with the intrinsic worth of the businesses they’re buying. I’m also with you that I don’t think the underlying businesses in their individuality are worth, intrinisically, much more inside the Judges structure than outside of it.

      So yes; a DCF is the right way to model Judges, as it is most things, but I think the simplified table I posted above isn’t a terrible proxy for that, since the implicit assumptions within it aren’t dissimilar to the assumptions I’ve made in my DCF model of Judges.

      I think the bulk of the value creation – if you want to call it that – is in point 4, and I’ll also push back a little in the core undertone, which is that you need to jump from why they’re ‘worth’ 5x EBITDA to why they’re suddenly ‘worth’ 15 EBITDA. What Judges pay for the businesses, as you correctly appraised before, is entirely irrelevant to what they’re now worth inside the group structure. The fact that Judges are able to acquire these businesses at 3-6x EBIT is entirely a function of supply and demand in the market of small, private, unlisted businesses. I would postulate that Judges’ track record, trustworthiness, the network they have of sellers and the opportunities that come from referral having closed deals in a transparent way in the past gives them a competitive advantage in sourcing these deals. A much, much more tangible barrier is that these deals are too small for many of the competitors.

      As to what these businesses are worth – in the section where I simply valued the trading businesses above, I talked about the 12x valuation they were trading at. I don’t think this is at all unreasonable.

      – While the businesses don’t have enormous scope for investing capital, having an extremely high RoCE (40%+) is incredibly relevant, even with relatively low levels of growth. The businesses Judges bought grew at mid-high-single digit rates in the years after acquisition. I don’t have the figures with me, but we’ll call it 7%. The difference between a ‘normal’ return on capital (we’ll say 10%) and 40% is enormous, even at this relatively low growth rate. A business with £5m of earnings at a 10% return on capital will require £3.5m of additional investment to support a 7% growth rate (5*0.07/0.1). A business with £5m of earnings at a 40% return on capital will require £0.875m (5*0.07/0.4). This is £2.5m (50% of earnings!) of extra distributable cash flow yearly, and justifies a significantly higher multiple; and the effect is still noticeable and relevant even when you start running at perpetuity growth rates. I also suspect that you can attribute above-market growth rates for the near-medium term as they operate in markets that seem likely to be subject to disproportionate growth.

      – The businesses do warrant a lower discount rate as part of the group – I agree with you there – and also warrant a fairly low discount rate anyway. Judges sailed through the recession with nary a worry, and it’s telling that in one of their ‘bad years’, it’s a ‘bad year’ because EBIT is 20% off previous levels. The business throws off very stable cash flows. Stability of cash flows is what I use as a proxy for the cost of equity I want to assign to the business.

      – … and if you want to tie the two previous points together, consider Spectris/Halma/Oxford Instruments, which are imperfect peers but give a decent flavor for how the market is valuing acquisitive testing/life science/ niche scientific businesses. All of these businesses have significantly worse returns on tangible assets and returns on acquisitions than Judges do, so will need much higher reinvestment through a DCF model. Given the multiples these businesses trade at, the implied discount rates of these businesses are either extremely low, or the implied growth rates are extremely high, even stripping through the ‘acquisition value premium’ effect. This is not necessarily to say that Judges is undervalued – the others might be overpriced – but I lean more towards the former than the latter (though I do think that yes, the others are too expensive)

      So yes, I think Judges Scientific is partly exploiting a sort of discount rate arbitrage between sellers and buyers, and partly enjoying the trust factor, but there’s also some old-fashioned supply and demand involved. The market for small, private businesses isn’t perfect.

      I think the point we probably fundamentally disagree on is the value of Judges in steady state after acquisitions have begun to taper down which, as a percentage of their assets, has probably already begun – or at least will do in the next few years.

      I think the group possesses businesses with excellent growth characteristics which need very little reinvestment – and this is absolutely crucial, because people very rarely factor in the enormous reinvestment in most businesses which are growing – that should be discounted at a relatively low rate because of the stability of the cash flows. Liquidity and size are two reasons why Judges doesn’t get the credit their peers get – and they should get more credit than them, not less – and both of these are problems that fix as the business grows. I don’t think using ‘acquisition price +x’ is at all a fair model for the value of the businesses they’re acquiring, because I think they exploit a genuine valuation difference between large, liquid listed businesses and businesses too small to go private. These businesses are fundamentally worth much more to public market investors in a digestible, tradable format than they are to retiring business owners who need cash, as you again point out.

      Hopefully this explains why a fuller DCF gets me to roughly the same place that my simplified model in the post does. Thanks again for the thoughts.

      • Mark Simpson

        Hi Lewis,

        All good points. Just for the avoidance of doubt I wasn’t suggesting that Judges be valued as an investment business just that the implication of considering it such rather than a ‘roll-up’ or a trading business could be negative not positive.

        Good to see you are on the same page as me which is essentially that Judges are such good capital allocators because they are able to buy streams of cashflow that are worth x at a significant discount to x. Not that a company worth y (<<x) suddenly becomes worth x because Judges are such good capital allocators. When I've had discussions over Judges in the past investors seem to get the direction of this logic confused so I'm pleased that you've clarified that that isn't the case and the percieved uplift is due to discount factor variance and behavioural factors not capital allocation 'voodoo' 🙂

        Re: reinvestment at 40% vs 10% ROCE even at a relatively low 7% growth rate – you are right of course on the economics of this – I just would have expected this to be reflected in the purchase price of the businesses. Even if I was 65 I'm not sure I'd sell my 40% ROCE, 7% growth business for 3-6xEBITDA but maybe that is where the market is.

        You are right that our difference merely comes down what level the true multiple should be for Judges. I'm more conservative because I'm concerned how many high ROCE private businesses they can buy for 3-6xEBITDA given that as they scale up they may start to face more competition. You may be right and there are plenty more to go for who will accept a low price for the unique Judges culture.

        One of my pet hates is the blind use of industry multiple averages (not that I'm accusing you of it here.) You know the type of argument, X is in the Technology sector with a EV/EBITDA of y. The average EV/EBITDA of the technology sector is 3y so therefore X should be 3x higher. It completely misses the point that X may have totally different ROCE, growth rates etc than the average company of the technology sector or the whole sector may be overvalued.

        Using other companies as a guide to the correct multiple can be a useful comparison (and the ones you mention are valued pretty similarly to Judges from a quick look on Stockpedia) but only if the business are similar in nature, growth prospects etc. The other thing to bear in mind is that there is a temporal dimension. If you are apply the same multiple today to 2019 earnings to get a 2020 valuation then the business has to have the same growth characteristics then as the company or comparator companies do today. i.e. no flattening of growth in maturity. Again just an area I would tend to be more conservative on than you, but hey that's what makes a market!



        • Lewis


          Yes, agree with you on all of it again. I had/have the same scepticism regarding the fact the business is able to buy so cheaply. I guess the only reconciling factor is that they have been executing this strategy for 10 years and, so far, they’ve delivered as they’ve expected. The businesses they bought did better after acquisition (so no fuddy-duddy accounting fluff), continued to generate excellent returns within the group, and grew at above-market rates. GIven how many they’ve done now, I relax my scepticism a bit. It seems unlikely to be pure luck or one-offs by now!

          On the multiples – a pet peeve of mine, too. As someone who’s now looking globally, it also drives me bonkers when people talk about EBITDA multiples across geographies – of course an Irish stock will have a higher EBITDA multiple, because those guys pay 12.5% tax, and their identical American counterpart pays 40%…? Your description of what a multiple ‘is’ above is the best one I’ve ever heard – it’s a shortcut to a DCF. It’s a neat heuristic to simplify figuring out what a business is really worth. The real problem is when you pretend it, in itself, is hugely insightful into telling you whether a company is over or undervalued.

          For what it’s worth, in Judges’ case, I think they score higher than the peers I mentioned on every front. Their returns are better, their growth has been better, and there are many more profitable opportunities for reinvestment. The market would probably argue that the stability of cash flows from the larger companies means they deserve a lower discount rate – and if that’s the argument, I’m quite fond taking the other side of such a self-fixing bet.

          On your final paragraph, again I’m with you. I have Judges tapering down significantly in terms of capital reinvestment as a percentage of their current capital base (so the rate of growth will slow or stop). You can’t say Facebook is worth 100x because it’s growing so quickly, and then say that in 10 years time when it’s making 5 times the revenue, it’s still worth 100x. The current multiple discounts the growth.

          That’s what makes a market indeed! I enjoy your thought process; I’d love to hear what’s exciting you at the moment?*

          *though I might intuit that you find the current implied price of equity in the market as a whole makes the whole shebang kinda unattractive for you at the moment.

          • Mark Simpson

            Thanks Lewis,

            Good point on the tax implications, another reason to be wary of multiples.

            One thing I like to do is to invert the multiple to get the implied medium term growth rate of the company. It is often easier to take a view if that is realistic or not than the other way round. With some of the higher rated companies the implied growth rate has them taking 50%+ market share with maintained margins. That could be a fair assumption if they are a duopoly or they have first mover advantage in a winner takes all industry (i.e. one where network advantages provide a sustainable competitive advantage) e.g. google. However that is unlikely to be realistic if they are a clothes or white goods retailer no matter how good their management are or how strong their initial growth appears when they are minnows.

            The other factor that people forget is the more one relies on a simple heuristic like EV/EBITDA the more diversification you need. If you bought the lowest decile of companies in every industry sector you would likely outperform the market over the long term. The mistake is to assume that the general result applies to the specific case and a specific company trading on a lower multiple than the industry average will revert to the mean.

            What excites me? Well as a bottom up value investor it is always the companies themselves combined with good portfolio construction and finding ways or implementing processes to mitigate my behavioural biases.

            You are right there is not much coming up as a buy on my watch list at current prices but then I am still close to 100% invested. Partly this is because I buy more on weakness and sell into strength so there are companies that I would buy at the current price if I didn’t already have the amount I’d like of them. Also, as with many value investors, I tend to sell too soon so I am trying to include some momentum in my decision making primarily via the stockopedia ranks. I also have no clue where the indices are going to go in the short/medium term – they seem highly rated, particularly in the US but then I also can’t see anything that will knock them down anytime soon (the Philosophical Econonomics blog has some good arguments why things like the Schiller CAPE are not a good guide to future equity indice returns) so I just ignore them.

            Companies that I like even after some recent strength are:

            Goodwin (GDWN) – Family owned – seems like a boring metal basher but always generates high ROCE so must have a sustainable comp. adv. dropped on fears of oil price exposure but I love how the presentation on their website shows 20 year of results. they will be focussing on shareholder return for next 20 years – does a couple of years of low POO really change the value of such a long term business?

            Energy Technique (ETQ) – great product, flying off the shelves at the moment, highly cash generative, almost all capex is discretionary. question marks are will they get an acceptable offer for the business? high end product – can they sell internationally if the London construction market cools?

            Pure Wafer (PUR) – straight value play – cash return could be more than current SP. If not then trading business likely sold makes up the difference. Classic Dandho – heads I win, tails I don’t lose much (if anything)

            Harvey Nash (HVN) – IT recruiter, seems very low margin so low rating but they are very good at trading well in all conditions since they have permanent, contract and outsource. means very low cyclicality in all business conditions. market should pay up for stability but trades at a discount. If they can get their margins up could see higher profits and multiple (I maybe falling for the multiple fallacy here but think it has some validity in this case.) Not much downside but optionality on the upside.

            Ones that are starting to look interesting but I’ve not done enough research on yet to come to any conclusion are Driver Group (what exactly do they do!? and is the recent blip delays and investment for future growth as they claim or real business problems?) and Fletcher King (is their current level of business sustainable?) feel free to do a write up for me if you like 😉

            Where I do aim to limit my exposure to the market is with some short positions – I always keep them small, always diversify and usually rely on the published work of others (e.g. WShak, Gotham City, Bronte Capital, Spruce Point Capital.) Often this in the US market due to the availability of research – I’m surprised how much US companies seem to manipulate their earnings reporting big differences between non-GAPP & GAAP. We get a few in the UK that are as blatant as Quindell but aside from those few and foreign domiciled frauds our earnings seem less manipulated? (or maybe I’m just experiencing some home bias!) I wonder if this could be where the next bear market comes from is all the US non-GAAP adjustments coming home to roost? The key imo to shorting is to take losses quickly when things go against you. This doesn’t always come naturally to me as a value investor and this is a lot easier when you haven’t invested significant effort into researching the company. I also don’t have the time or the inclination to write 100+ page short theses or to visit factories in China so I’m quite happy to critically analyse the work of others and invest on this basis. So all in all second hand research works well for me here.

            Hope that’s interesting.



            • Lewis

              Thanks Mark – always interesting to see what other people are thinking about, and it’s clear we have a lot in common here. ETQ and PUR are both great ‘special sits’-y investment cases, and Goodwin is (as you point out) something of an impressive mystery. It’s not entirely clear to me how they do as well as they do given the sector they’re in, but I suppose at some point – much like Judges – one has to accept that they do seem to have some sort of advantage that lets them earn a real economic return. Perhaps the ownership structure and company culture pull them through on that front. I just worry a bit about the depth of the pain they’ll feel from oil & gas exposure. Call me a trader, but if the order drop really bites – and it could, as management don’t give much away to the up or downside – I think a better entry point might come up.

              I do some short-esque stuff too, though I’ll admit it’s not a particular strong point of mine at the moment. My investing history to now has been entirely long, and it does require something of a shift in mindset!

  3. Lewis

    “Richard Beddard ‏@RichardBeddard 3h hours ago

    @ExpectingValue Hi Lewis, your figures and Judges’ add back amortisation, but it’s a huge component of EBITA. Doesn’t that make you queasy?”


    While I’d love to have the brevity to answer the question in 140 characters, even this preamble takes up more than that!

    All of Judges’ amortisation is amortisation arising on assets from acquisition. All of their internal R&D is expensed immediately – run through the P&L and not put on the balance sheet. This is an important distinction.

    When companies consummate acquisitions nowadays, the accountants in the acquiring company have to go through purchase price allocation. This is where they look at what they’re acquiring and, instead of simply calling all of the intangible stuff ‘goodwill’, they break it down into more finite detail. We’re acquiring 500k worth of ‘customer lists’, for instance, and maybe another 200k worth of ‘trademarks’, 400k of ‘customer relationships, 900k worth of ‘non-competition agreements’, 200k of ‘brand names’… and so on.*

    They then amortise this over a set period of time – you can see the schedule on page 15 of their most recent annual report. I can sort of see why accountants have chosen to do it this way. It implies that after 5 years, most of the intangible ‘stuff’ you acquired on acquisition has sort of faded away as the business has been incorporated into the wider group. The group doesn’t mind, of course, because this amortisation is tax deductible. It is also – obviously – entirely a non-cash cost. You are just reducing a hypothetical balance on your balance sheet. And reducing your cash tax bill, which is far more real…

    I exclude the amortisation of these intangible assets because I looked at Judges and asked myself one question – amortising these assets down to 0 implies that the ‘competitive advantage’ these businesses have – the source of their supernormal profits – is fading away over time. Is this true in Judges’ case? Given the continuing strong organic growth and margins, I don’t think so.

    EBITA is hence a much better proxy for long-term run-rate cashflows, since the accounting wizardry bundles in a number of non-cash costs that are finite in timeframe and do not reflect any underlying cost to the business, or deterioration in those businesses.

    * I am not an accountant, so this is my understanding, and not the understanding of a qualified person!

  4. red

    Spend a quid to acquire 20p of after tax cash flow that is valued at 15x in the public market — i.e. turn one pound into 3 and keep going, making larger acquisitions as you go, compounding your capital until you’re Danaher.

    Was a cult stock 3 years ago but this is the first time I’ve seen it mentioned in the past year.

  5. Charles Hang

    This is really interesting–just one question: Have the results of Judges’ competitors also see a downturn in the past couple of years? I think it would be nice to make sure that the decline in Judges’ earnings is because of market-wide factors rather than issues with the company itself.

    • Lewis

      Charles – completely the right question to ask.

      Oxford Instruments is probably the best comp, since they earn the highest proportion of sales to research/academic.. Spectris and Halma have more commercial exposure. Oxford Instruments have seen a broader downturn in the last few years. Their margins have contracted pretty significantly, though their top-line has grown through some acquisitions.

      But the correlation isn’t perfect. The neatest macro-factor you could tie it to would probably be higher-education and research institution capital goods spending, but I can’t think of a data set or a good proxy for that. Broadly, my working assumption is that spending (which is often quite closely tied to public sector budgets) certainly hasn’t been going up given all the fiscal contraction in the last few years, but that the area generally is in a very positive long-term growth trend. Whether it’s growing from this lower base (i.e., the dip is cyclical) or whether it’ll rebound (which seems unlikely) is a question I’m not really equipped to answer, but I don’t think the business is priced to need anything like a rebound.

        • Lewis

          I should note that Oxford Instrument’s numbers yesterday were pretty limp. They’re not seeing much recovery in public sector order volumes, which does have some read across to Judges…

          … though relatively limited, as Judges is an esoteric and idiosyncratic little company!

          Nonethless, one probably shouldn’t (and I’m not) be pencilling in any imminent short-term improvement in their outlook.

  6. Jisare

    this reminds me a lot of constellation software.
    My question is how is the acquisition pipeline? How are we sure that they can consistently find retiring niche scientific instrument company founders in the future, and even more in the future?
    Any other reason they can acquire at 5*ebit other than retiring founder?

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