SDI PLC
The essence of value investing
Company: SDI. London Stock Exchange
Market Cap 61m GBP
Price 58 GBX
Growth versus Value
I see that the consensus on X and podcasts is that Value investing and growth investing make no difference, and that all investing is value investing.
I disagree.
While it is technically and mathematically true that value and growth are joined at the hip, there is a big difference between the value investor and the growth investor, in terms of the strategy employed.
To perform well in highly valued companies, you need higher skills in selecting the growth companies with the best future prospects.
The growth investor predicts the future cash flows based on the company growth potential. For this, he needs to do a very complex analysis of the future growth avenues, the moat, the competition, the new products and the catalysts. This is very complex. If done right, it allows for multibaggers, and even if the multiple paid is high. The successful growth investor is intelligent and knowledgeable about the company.
The problem is that many fail to succeed and disappear from the investing scene. The downsides are higher. Moberg Pharma is a good example. It was a very hyped early stage pharmaceutical company with a promising product, the stock went up a lot with many retweets and write ups promising the moon. It reached the moon temporarily and then had a clinical trial setback, and the stock tanked. It might recover and do well, but it was always a high risk high reward company.
To do well in high multiple growth companies, you need to be very very skilled, and to balance your risk. The list is endless, from Peloton to Zoom and Sea Limited, to early Alibaba in the 2010s.
There are a few good growth investors and fair play to them. But you only know the good ones after they display staying power and good choices over a decade in my opinion.
The value investor
The value investor generally will not aim to buy at a high multiple. He acknowledges the difficulty in predicting the company's growth rate. He does not believe that DCFs are informative and in most case they do not stand the test of time. Go and check all the old DCFs on SDI plc if you want to verify.
While growth will determine the outcome of his returns, the value investor will buy the company at a low multiple so that even if there is no growth, he comes out with a decent result or a small loss.
The base case is that the growth is not there, and the bull case is that the growth returns or continue. In the base case, you get only a result produced by the recurring earnings yield plus maybe some rerating. In the bull case, the optionality of a return to growth allows for outsized returns.
Best of both worlds
I think that a good way to capture both growth and value is to look for companies that trade at depressed multiples but still could growth in the future, and have the discipline to continue holding as long as the fundamentals continue to grow.
The big error of the value investor is to sell too early, like Berkshire or Mcdonalds in 1990 after a 100% gain.
The reason why I profile many companies is because I apply the Value buy and coffee can hold. The Coffee can portfolio is the idea of putting your stock certificates in a coffee can, in a safe or where ever, and never sell.
It creates some huge multibaggers and a lot of average results. It works well for growing companies or companies with very high dividend yields like in tobacco.
Therefore I will keep the companies that I bought early like Terravest after seeing the company presented, or like First Pacific. And I will take the dividend elsewhere for new value “bets”. What I don’t know well how to handle yet is a complete overvaluation of holdings. In that case it makes sense to sell if you are sure 100% than the other value proposition in a new stock is much better, because there are capital gain taxes.
The Company:
Let’s go to SDI PLC. SDI is a small cap serial acquirer from the UK.
It buys and keep niche companies in the scientific and sensors industries.
As a serial acquirer, growing by acquisition is a good way to boost earnings, by buying small companies at low multiples.
The revenue and net income grew a lot.
But after 2022, the normalised net income decreased. It was simply that the Digital Imaging segment had a major Covid Boost. Earnings from 2022 to 2022 as you can see on the chart more than doubled. This is when many people started writing about SDI.
I posted a Meme on X, and it actually worked exactly like this.
As you can see, all the write ups are from where the stock was high, except some updates by Momentum newsletter, that I recommend for the ability to remain cold headed and to follow thesis irrespective of the stock *momentum*. Actually, if you like SDI, go read their meeting with the new CEO (link at the bottom)
The reports were good, nothing bad (apart from often not questioning the boosted earnings nature) and focusing too much on details in my opinion, which are already outdated, such as CEO background, because he left, or granularity of each subsidiary, which does not help any decision taking.
The biggest question I had…
But overall these write ups were incredibly useful. And the first people who found SDI were really doing a big favor to people like us, value investors.
Also, because it was written up many times, I will make it short and concise on SDI. I prefer to write original content and a quick search will give you many detailed write ups about the background of the company.
They rightly identified the main points:
1-The valuable nature of the niche industries.
2-The valuable acquisition strategy.
The life science industry and high tech scientific product is a secular growth industry with limited downturns.
SDI operates in the life science segment niche with long term organic growth (5-8%), and many small companies to acquire cheaply.
The company has 40% of sales overseas.
It generated 7.3 million GPB of Free cash flow over the year. But working capital + acquisition + negative organic growth makes it look like there is no cash generation.
Net debt is 13.2 million GBP and EBITDA is not disclosed, but operating profit nears 10 millions, making it a very low leverage company.
The new CEO is also implementing a synergy strategy, not in terms of cost cutting, but about knowledge collaboration and commercial synergies such as cross selling.
SDI still has an active M&A pipeline.
So what happened?
After the covid, the earnings came back to earth, with the consequent destocking as well and the impact of the economic slowdown.
There was too optimistic guidance, disappointment, and a change of CEO who kind of misled investors about the guidance.
Investors gave up, and sold and sold. Until the valuation reached about 8-10 times stabilised earnings.
The investors were saying a the same time that the old CEO deceived them, and that the new CEO cannot do as well as the old CEO in terms of acquisitions. There is a contradiction here!
I was thinking the following, “well the new CEO cannot be a full idiot that does not know how to run and grow a company”. He has to be a decently smart person, and is able to read and understand the serial acquirer value creation mechanism.
Often we as investors tend to think ourselves as superior to a new CEO who has years of experience in the business and industry, without giving him/her a chance.
We understand serial acquirers, and he does not. We understand capital allocation, she does not. This is plain arrogance. A risk that could happen in general is a CEO with a different goals than share value, something more like empire building. But they are not stupid.
Conclusion.
What matters with SDI is that we pay for zero growth. 8 to 10 times earnings, defensive. Good free cash flow conversion. A 10-12% earnings yield on entry.
What is likely going to happen?
Some acquisition will increase the earnings profile, then it will rerate a bit, then another acquisition, then another rerating. It will get loved again. Results could be inline, nothing spectacular. earnings will start growing, and we should get a compounder again.
Some resources:
Another message was found on the UK shares forum posted by user Rivaldo:
“FYI the recent September issue of Techinvest reviewed the prelims and concluded thus:
"SDI completed a strategic review during the year, leading to a re-segmentation of the portfolio under three areas: Lab Equipment, Industrial & Scientific Sensors and Industrial & Scientific Products. Management sounded confident that this will enable further synergies for complementary businesses. The five-year CAGR track record for the group remains impressive, at growth of 28% and 20.1% in revenue and adjusted operating profit respectively.
Acquisitions have played a key part and management see potential for one or more further additions in fiscal 2025. SDI’s expectation for longer-term organic growth,
following the strategic revenue, is in the range of 5-8%.
Consensus broker forecast for the current year is net profit of £7.5m and earnings per share of 6.0p. We feel that a prospective P/E of 10.8 represents excellent value given the rate of top- and bottom-line growth SDI has been delivering in recent years. Buy."“
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I've made SDI top 2 position with a 74 gbx average cost for now (im still buying). Surprisingly, it's dirt cheap with two catalysts (lower rates mean lower interest payments on their debt, plus they have already said they are negotiating an acquisition at historic multiples of 4-6x EBIT). Don't know how this doesnt work out lol
I have been looking at quality serial acquirers and I have noticed a lot of them have dips in profit and/or revenue in 2024. So I think the inventory destocking argument is probably credible.