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Investment Times

Choosing shares for long-term growth

| 3 June 2015 | A A A
Choosing shares for long-term growth

No recommendation

No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Cash is king. If a business can generate cash for reinvestment, it can fund its own growth without going cap-in-hand to the banks or asking shareholders for more money. Here are three examples of ways companies could achieve growth over many, many years.

High margins

One of the best ways of generating cash is to have a business that makes a high return on the capital invested in it in the first place, with relatively little need to reinvest that cash into physical assets to generate more cash next year. Easier said than done, but one company that we believe has made something of an art form of this is Halma.

Halma manufactures products used to improve or protect health, safety or the environment. These products, such as safety sensors or water-analysis equipment are critical to its customers’ compliance with regulations; they have to invest in these areas through thick and thin.

Customers are willing to pay for products that perform vital tasks and Halma has made profit margins in excess of 16% for over 25 years. Halma’s return on operating capital is over 70%, making the business highly cash-generative. The company reinvests this into buying complementary businesses that fit their criteria, so investors have benefited from a combination of organic and acquired growth. This growth has allowed Halma to raise the annual dividend by at least 5% for the last 35 consecutive years. Please remember there is no guarantee this will continue as dividends are variable and not guaranteed.

Halma - Return on Capital Employed

Source: Halma Plc

Halma

  • Share Price: 759.5p
  • 12 month change: +34%
  • Market cap: £2.9 bn
  • Index: FTSE 250
  • Operating Profit FY 2015: Est. £148m
  • Operating Margin FY 2015: Est. 20%

Past performance is not a guide to future returns; yields are variable and not guaranteed. Correct as at 21/05/15. Source: Bloomberg and internal.

More information on Halma shares

Expansion

A business may have a successful formula, but the challenge starts when trying to expand to a larger audience. For a retailer, that can mean opening new stores in new cities. Burberry has been a great success since it demerged from the old Great Universal Stores in 2005. However, it is still small compared to luxury goods giants like LVMH or Richemont.

Burberry - directly operated stores

Source: Burberry Plc

This means it has plenty of scope to expand by opening stores in new locations, without cannibalising business from its existing stores. It’s doing a lot more too, taking control of its perfumes in-house and building a beauty business around them. The strategy of building the brand and taking it to new places has allowed Burberry to grow sales and profits several times over, building a cash pile of over £500m along the way. In the short term, foreign exchange movements are taking some of the gloss off Burberry’s underlying growth. However, the business is continuing to expand its footprint which we believe should enhance earnings for the group and its investors in the future.

Growing into the empty spaces on the map could drive Burberry for some time, and with operating margins in the high teens, I believe Burberry should comfortably fund its own expansion.

Burberry

  • Share Price: 1695p
  • 12 month change: +13%
  • Market cap: £7.5 bn
  • Index: FTSE 100
  • Operating Profit FY 2015: Est. £440m
  • Operating Margin FY 2015: Est. 17%

Past performance is not a guide to future returns; yields are variable and not guaranteed. Correct as at 21/05/15. Source: Bloomberg and internal.

More information on Burberry shares

Patents

Intellectual property (IP) can be a huge asset, if it allows you to do something of great value and then prevent others from doing the same. One UK technology company that has been a raging success with IP has been ARM. The company designs the processors at the heart of silicon chips and then sells its designs to other technology companies.

ARM Holdings - % profit margin

Source: Arm Holdings Plc

Designing a processor costs many millions of dollars, and ARM spends around 25% of sales on R&D, protecting it with patents whenever it can. Customers don’t want to risk so much designing their own, so they pay to license ARMs designs instead and then pay a royalty every time they make a chip using them.

ARM’s chips are very energy-efficient and have taken huge market share in mobile phones, because they stretch battery life. It seems unlikely that demand for electronic devices will fall and if ARM can maintain its profit margins of 40% (and rising), the company could continue to be highly cash-generative.

The company trades on around 35x prospective earnings, but so far it has delivered enough growth to keep the market happy. Adjusted earnings last year were 24.1p, with consensus suggesting this could double by 2018 as more and more of its chips are used each year.

ARM Holdings

  • Share Price: 1118p
  • 12 month change: +30%
  • Market cap: £15.7 bn
  • Index: FTSE 100
  • Operating Profit FY 2015: Est. £480m
  • Operating Margin FY 2015: Est. 49%

Past performance is not a guide to future returns; yields are variable and not guaranteed. Correct as at 21/05/15. Source: Bloomberg and internal.

More information on ARM Holdings shares

These three companies have all used different means to achieve their robust cash generation, but each path has led to consistent growth over a long period of time. As ARM shows, technological leadership can be the means to achieve this, but equally, Halma and Burberry demonstrate that it is far from the only path.

References to specific securities should not be construed as a recommendation to buy and sell these securities either explicitly or implicitly, or an opinion on present or future value of securities.

Photo credit: Elena Dijour/shutterstock.com

The value of investments can go down in value as well as up, so you could get back less than you invest. It is therefore important that you understand the risks and commitments. This website is not personal advice based on your circumstances. So you can make informed decisions for yourself we aim to provide you with the best information, best service and best prices. If you are unsure about the suitability of an investment please contact us for advice.