This 'buy and build' strategy ticks all the boxes

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This 'buy and build' strategy ticks all the boxes

Since I made a New Year's resolution to consider only one trade a month, I've added more Cohort (CHRT) shares to the Share Sleuth portfolio, reduced its holding in Games Workshop (GAW) and decided to hold back from adding more shares in Alumasc (ALU). Rationing trades this way should mean I spend more time researching and less time worrying about trading, which will help me buy and hold shares in good companies at reasonable valuations for the long term.

The policy has not done anything to reduce the portfolio's cash balance, though, which has built up through the payment of dividends and past sales. Earlier this month cash stood at over 12% of the Share Sleuth portfolio's value, so I'm pleased to report I've added shares in Judges Scientific (JDG). Even better, Judges is a new addition, so the Share Sleuth portfolio becomes a little more diverse.

In some ways, Judges is a long-term investor like me. It describes itself as 'buy and build', which means it buys businesses and then operates them. The business model is a bit more complicated than that, though, because of the particular companies it buys and the way it buys them.

Highly profitable

Judges buys small, successful, scientific instrument manufacturers that already earn good profits because they have developed equipment that helps scientists, mostly at universities but also in industry, measure things. The businesses are very specialised, which has two ramifications, one good, one limiting. They're highly profitable, but growth potential in their niche markets is often modest.

Judges borrows money to buy the businesses. It uses some of their profits to fund research and development, enabling them to stay competitive, and uses the surplus to pay back debt, freeing up funds to buy the next business.

While the firms Judges buys should grow modestly over time, the group should grow faster because it can borrow at much lower interest rates than the annual returns it earns from the firms it buys.

For example, if Judges pays four times EBIT (earnings before interest and tax a measure of profit) for a company, it will earn a 25% annual return on its investment for as long as the acquisition sustains those profits.

Source: interactive investor               Past performance is not a guide to future performance

So far, Judges has made 16 acquisitions and never paid more than six times EBIT. Often it's paid as little as three times EBIT. To put that into perspective, in the current market I find it difficult to find good businesses trading below 15 times EBIT.

Even though I've paid a full price for shares in Judges - it's currently valued at about 15 times EBIT - "the train is still going", its founder and chief executive David Cicurel tells me. In other words, shareholders will benefit from future acquisitions at low prices.

There are challenges ahead. While I expect the march of technology to continue, I wonder about higher education, which, at least in developed economies, has rapidly expanded. Also, as Judges grows, it must either buy bigger firms or lots more smaller ones to have the same impact.

The market for bigger companies is more competitive, which means higher prices; and as the number of companies Judges owns increases, they might become more difficult to manage.

Nevertheless, I am impressed with what Judges has achieved in its first 12 years of acquisitions, while also cognisant that bigger buy-and-build operations, like Judges' much admired rival Halma (HLMA), are still growing.

I've added 150 shares at a price of £23.20, deducting £10 from the portfolio's cash balance in lieu of broker fees. The total cost was £3,490, about one 30th the value of the portfolio - the maximum I put at risk in one go. The portfolio's cash balance now stands at 9% of its total value, down from 12% in last month's update.

Three of the companies profiled in this month's Share Watch in the magazine are Share Sleuth portfolio constituents. They are: Howden Joinery (HWDN), XP Power (XPP) and Science (SAG).

Source: SharePad                  Past performance is not a guide to future performance

This article was originally published in our sister magazine Money Observer. Click here to subscribe.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation, and is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.