Questor: Halma looks like the perfect investment – except for its valuation. Take profits now

The stock offers much that is ideal from an investment perspective: the mandatory nature of purchases of its products, thanks to health and safety regulations, creates consistent business flows and loyal customers, a combination that provides a degree of pricing power. That in turn can mean high margins, good returns on capital, strong free cash flow and that consistent dividend growth.

The only problem is the valuation, at 30 times forward earnings. It would be unwise to equate quality with safety and such a rating leaves no margin for error, either at company or a wider market level.

Very long-term portfolio builders can happily hold this one, but a 33pc gain in the past eight months may be hard for some to ignore given how tricky markets feel right now. Take profits.

Questor says: take profits

Ticker: HLMA

Share price at close: £12.97

Update: Centrica

In October this column suggested that Centrica’s shares, then at 172.8p, might find support at the 170p level, as such a decline would factor in a halving of profit margins to 3pc and a dividend cut from 12p to 9p.

So much for that theory. Last Thursday’s trading statement suggested that trading had been even tougher than expected and the shares were driven to multi-year lows, leaving this column sitting on an uncomfortable loss.

There was some good news, as we had anticipated. New revenue streams are developing nicely, as evidenced by the 59pc jump in sales of connected products and services. Even the UK consumer business’s profits are on track thanks to cost-cutting, despite the regulatory pressure and loss of 823,000 customers.

However, the plunge in returns from the US business-to-business activities is alarming in both its degree and speed, even if a chunk of the shortfall is down to what the company says is a £46m one-off charge. This raises fresh questions about the 12p-per-share dividend. The market does not appear convinced by chief executive Iain Conn’s reassurance that the £675m pay-out for this year is covered by cash flow of £2bn, especially as capital investment is due to come in below £1bn.

Centrica’s 8.7pc yield is eye-catching but lies ominously in “too good to be true” territory. The lack of pricing power in the US business is worrying. And the lack of even a minor bounce in the shares in the wake of Thursday’s collapse suggests that investors are waiting to sell into any rallies rather than buying on any dips, pending further clarity on the dividend, which could yet go below 9p in the event of a real “kitchen-sinking” exercise.

There are three lessons to be learned here.

First, listen to the market. The share price chart told us something was wrong, especially once the 170p level gave way. The market cannot always be right, but its opinions should always be respected.

Second, this is why investors need to run a balanced portfolio that encompasses a range of stocks and sectors to help protect total long-term returns from accidents such as this.

Finally, always keep a checklist of why you like (or dislike) a stock and keep it up to date. If events do not pan out as expected and the original analysis proves faulty, or something unexpected has happened, it may just be time to move on. If everything you expected to happen did happen and the stock has rocketed, it may still be time to take profits if the valuation now looks lofty.

And if all is going as well as expected and the shares are still looking cheap, it could be time to buy more on any weakness (as long as a portfolio does not become too exposed to this individual holding).

Income investors may be tempted to give Centrica’s dividend a chance, but the risk of a deep cut is growing, so the safest option is to accept the loss and move on.

Questor says: sell

Ticker: CNA

Share price at close: 138.5p

Russ Mould is investment director at 
AJ Bell, the stockbroker