Diploma (LSE:DPLM) has been on my list of the best UK shares for some time. And with the stock slipping 4% in January, I think it looks like a decent time to consider buying.
It’s worth keeping that decline in context – the stock is still 14% more expensive than it was this time last year. But I still think it’s a great choice for investors looking to build wealth.
The company
What makes a great investment? In my view, the best companies have two things in common – strong cash generation and an ability to fend off competitors.
Diploma fits the bill in both cases. The business brought in £189m in operating cash last year, but the most impressive thing is that it did this with just £130m in fixed assets.
That means the firm is able to use its property, plant, and equipment in a way that they generate enough cash to pay for themselves every single year. That’s extremely impressive, in my view.
Furthermore, Diploma’s businesses typically operate in niche industries. Larger firms are therefore disincentivsed from competing with them because the market isn’t big enough to justify doing so.
Diploma’s approach has seen it produce strong results, especially over the last few years since its CEO took over. And I think it’s a strategy that can keep generating more growth going forward.
Recession
With the stock trading at a price-to-earnings (P/E) ratio above 30, investors are expecting a lot from the business. And there are a number of short-term challenges for the company in this regard.
The Bank of England has announced it intends to prioritise bringing down inflation over boosting economic growth. That’s fine by itself, but it’s not likely to be good for Diploma.
The risk for investors is that a downturn in manufacturing and construction might well cause demand for the products Diploma distributes to drop. And that will make the stock look expensive.
This is a genuine risk, but I think it’s important not to overestimate it. The business has been through recessions before, most notably during the pandemic, and emerged strongly as a result.
If earnings growth slows temporarily, I think this might create a rare opportunity. I like the stock at today’s prices, but I’d like it even more if investors get distracted by short-term headwinds.
The road to £1,000,000
Turning a £1,000 investment into £1,000,000 is likely to involve a lot of risk. And I’m not saying Diploma shares are going to be able to do that – they almost certainly won’t.
I do think though, that investing £1,000 each month in quality companies could ultimately make someone a millionaire. And Diploma might be a fine place to start this month — after careful research, of course.
At the start of the year, an investor could have got 28 shares in Diploma for £1,000. At today’s prices, that same sum buys 30 shares.
Building wealth in the stock market takes time. But Diploma shares look to me like a possible opportunity for investors who are prepared to be patient.
