Yahoo Finance Questor: this FTSE 100 stock’s 68pc gain is just the start. Keep buying
When Questor first tipped FTSE 100 member Diploma in October 2022, the company’s shares had just experienced a 28pc decline over the previous 10 months. Since then, shares in the supplier of specialist technical products such as gaskets, wiring and seals have soared by 68pc and outperformed the FTSE 100 index by 53 percentage points.
This represents a very encouraging performance in a relatively short period of time. However, this column firmly believes there are further capital gains and index outperformance ahead. Although the stock’s price-to-earnings ratio has risen from 28.7 at the time of our original tip to 32.4 today, which is substantially higher than that of many large-cap shares, the company’s growth potential means its elevated market valuation is fully justified.
The company’s recently released half-year results showed it is making excellent progress in implementing its long-term strategy. Revenue rose by 10pc, when the impact of acquisitions is included, while the company’s operating profit margin moved 80 basis points higher to 19.6pc as costs were effectively managed.
An impressive first-half performance prompted an upgrade to the firm’s full-year financial guidance. It now expects sales to rise by 16pc, versus a previous forecast of 11pc. The company also anticipates that its operating profit margin will amount to 20.5pc for the full year, which is 80 basis points higher than its previous forecast.
But this level of growth would not represent an anomaly. It has an excellent track record of generating strong financial performance over a sustained period, with earnings having risen at an annualised rate of 15pc over the past 15 years. This highlights the scale of the firm’s competitive advantage, with a return on equity figure of 21pc in its latest financial year, despite having very modest debt levels, evidencing its strong competitive position.
Diploma’s sound financial position is also proving to be a major asset and a key source of long-term growth. A solid balance sheet enabled it to invest a total of £284m in six acquisitions during the first half of its current financial year. And with the company’s net gearing ratio standing at a very modest 39pc, while operating profits covered net finance costs in excess of 12 times in the first half of the current year, it has the financial capacity to conduct significant further M&A activity through which to boost its top and bottom lines.
While the company’s shares have surged higher over recent months, asset price rises elsewhere have proved to be far more sluggish. This means that the firm continues to have a wide range of available opportunities to buy high-quality companies at attractive prices.
Separately, an improving economic outlook is set to act as a positive catalyst on the company’s financial performance and share price. At the time of our original tip, inflation was at obscene levels that had not been witnessed for decades, if at all, across several major economies. This made the prospect of interest rate rises seem somewhat inevitable and the idea of monetary policy easing feel rather distant.
While inflation remains above central bank targets in the US, UK and the Eurozone, which together account for around 85pc of Diploma’s sales by region, increasingly accommodative monetary policies are firmly on the near-term horizon.
Indeed, the European Central Bank has already cut interest rates and it would be unsurprising for its peers in the US and the UK to do likewise over the coming months. Once time lags have passed, this should create stronger operating conditions for the company and boost investor sentiment towards risky assets such as shares.
Encouragingly, the firm’s diverse geographical exposure, and wide range of operations, equate to lower overall risk for investors. This is likely to be of particular importance given the ongoing uncertain political outlook in the UK and the US.
Clearly, some investors will balk at the idea of paying an earnings multiple of 32.4 for a FTSE 100 stock. But in Questor’s view, those same investors are likely to have used the same reason for avoiding Diploma’s shares at the time of our original tip.
Given the company’s solid financial position, sizeable competitive advantage and impressive long-term growth potential amid an improving economic outlook, its shares continue to represent a highly worthwhile purchase even after recording a 68pc capital gain.
Questor says: buy
Ticker: DPLM
Share price at close: £40.94
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