FTSE 100’s quality compounders plus other stocks to consider

The loud returns of “quiet compounders” Halma (LSE:HLMA) and Diploma (LSE:DPLM) were today flagged by a City bank after it said their valuations were attractive for the opportunity and quality at hand.

Berenberg lifted its Halma price target by 500p to 3,750p, describing the safety technology firm as “arguably the highest-quality company in our UK industrials coverage”. The shares were today at 3,326p, having risen by more than 20% this year.

• Invest with ii: Top UK Shares | Share Tips & Ideas | Cashback Offers

The “simple but effective business model” of controls, seals and life sciences specialist Diploma makes it one of the UK’s “highest-quality UK companies”, according to Berenberg.

By comparing Diploma with a peer set of leading global compounders and with significant capacity for M&A, the bank increased its price target to 6,350p from 5,750p.

The shares today stood at 5,520p, up 29% this year and double their level of May 2023.

At a respective £7.2 billion and £12.3 billion, FTSE 100-listed Diploma and Halma are the UK market’s best-known examples of quality compounders.

Their business models combine the defensive attributes of increasingly diversified, repeatable revenues with the offensive upside of disciplined acquisition-led growth. 

However, Berenberg believes their valuations have been impacted by a tendency to only consider them against a UK mid-cap industrial basket that they have now outgrown. 

It believes their scale and attributes warrant comparison against other established long-term European and US compounders, leading to the bank's implied price/earnings multiple of 32 times.

Berenberg said: “In part, we use this note as a rebuttal to the pushback we often have of ‘too expensive’, whereas on the contrary we think respective valuations are attractive for the opportunity and quality at hand.”

It said the quality of Diploma’s earnings has significantly improved in recent years, while the company has upgraded guidance twice in as many months over the summer.

• Retirement case study: how I manage a £2.5m SIPP and ISA portfolio
• Is global bond market sell-off a golden opportunity?

Diploma’s decentralised model looks to empower localised operating companies to outcompete peers by giving them access to a FTSE 100 management team, considerable balance sheet firepower and group-wide investment.

Halma is focused on key growth themes in safety, environment and healthcare, which together with strong market positions in its target niches drives a highly attractive compounding financial framework.

High US exposure, pricing power, potential recovery in healthcare and leading risk-adjusted returns underpin Berenberg’s view that Halma should form part of investors’ portfolios. 

Berenberg’s new price target reflects its view that the group has momentum to add acquisitions, which will result in 2026-27 upgrades underpinned by strong organic growth.

The report adds that Judges Scientific (LSE:JDG) and discoverIE Group (LSE:DSCV) are beginning to show merit of being compared among a global peer set, although both are still earlier in their journey.

AIM-listed Judges Scientific, which acquires and develops companies in the scientific instrumentation sector, has a price target of 7,900p compared with today’s level of 6,300p.

Between 2015 and 2023, the company’s revenues grew at a 12% compound rate and margins progressively improved to 26%. It has also deployed over £170 million across 24 acquisitions since its inception. 

Near-term earnings volatility has impacted the investment case, leaving the shares 27% lower year-to-date.

The bank said: “Our positive view is predicated on the underlying attractions of the niche end-market positions and structural growth. However, current markets are clearly difficult, but growth should normalise on a 12 to 24-month view.”

DiscoverIE, the designer and manufacturer of customised and specialist electronic components, has a price target of 950p. It has lost 16% this year to stand at 593p.

• Is Anglo American deal a ‘game changer’ for shares?
• Budget delay hits rate cut outlook

Berenberg said the company’s end markets of medical, industrial connectivity, transportation, renewable energy and security benefit from long-term thematic growth drivers.

Engineer-to-engineer sales processes and designed-in products offer sticky customer relationships and repeatable revenues over end-product life cycles. 

Berenberg said: “Despite recent revenue headwinds, the group has seen both earnings and margins improve, and we point to a demonstrable track record of through-the-cycle organic performance and earnings growth as an indication of what is to come.

“While there remains lingering market risk around uncertainty in global policy making and mixed industrial end-markets, we expect that, in the near term, discoverIE should see a return to organic growth, which has been temporarily held back as a result of customer destocking cycles.”

The report also takes a brief look at where the next compounders could evolve from, highlighting Smiths Group (LSE:SMIN), Weir Group (LSE:WEIR), Rotork (LSE:ROR), IMI (LSE:IMI) and Spirax Group (LSE:SPX) within its capital goods universe.