Anyone who decided to buy Diploma (LSE:DPLM) stock at the end of 2018 made a great investment. But the company wasn’t an obviously rewarding candidate back then.
The stock traded at a price-to-earnings (P/E) ratio of around 25 and came with a dividend yielding under 2%. Investors who could see the company’s potential, though, have been richly rewarded with the stock now trading at an all-time high.
Returns
In general, US stocks have outperformed their UK counterparts over the last five years. But the returns Diploma has generated show that this hasn’t been the case across the board.
A 185% increase since the end of 2018 is greater than Netflix (+72%), Amazon (+83%) and Alphabet (+158%). And the company has also paid its shareholders a dividend during that time.
That means if I’d invested £1,000 in Diploma shares, I’d have an investment with a market value of £2,855 today. And I’d also have received £176 in dividends, taking my total return to 203%.
With the FTSE 100 returning around 33% over the same period, 203% is undeniably impressive. But I think there are some important lessons for investors from this.
A value stock
At a P/E ratio of 25, Diploma shares weren’t obviously cheap. But this demonstrates Warren Buffett’s point about it being better to buy a quality company at a fair price than vice-versa.
From an investment perspective, value isn’t just about low P/E multiples. It’s about looking for opportunities where a firm’s share price is low compared to the cash it can generate in future.
This has turned out to be the case with Diploma. It’s share price back in 2018 equates to 13 times its earnings per share from 2023 and the business isn’t showing any signs of slowing down.
This raises the question of whether the stock might still be one to consider today. It trades at a P/E ratio of 38, but the last five years have demonstrated that this, by itself, shouldn’t be a red flag.
Can Diploma keep growing?
Diploma’s impressive growth has been the product of acquiring businesses and making them more profitable. But this can be a risky strategy.
The biggest danger comes with overpaying for an acquisition. If the company does this, then it would be likely to turn out badly for shareholders.
This risk can’t easily be dismissed — even Warren Buffett has overpaid for acquisitions, as Berkshire Hathaway shareholders will know. But Diploma does have one important advantage.
Compared to Berkshire, Diploma is small. This means it should have a good range of opportunities available, reducing the risk of having to pursue an acquisition at an unfavourable price.
A stock to consider buying
It’s hard to buy a stock that’s at an all-time high. Investors who decided to stay away from Apple shares after a 137% increase in 2009, though, would have missed out on a 2,598% gain!
I’m not saying Diploma is going to achieve that kind of return. But to me, the company’s success looks durable, so I’m keeping it firmly on the list of stocks I’m looking to buy in the near future.
