Chances to buy shares in quality businesses at good prices don’t come around often. But the Diploma (LSE:DPLM) share price just dipped after the company’s latest trading update.
The company is still growing impressively and the outlook for the year is unchanged. So is the slight downturn in the stock a buying opportunity for investors?
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Company overview
Diploma is a distributor of industrial components. More accurately, it’s a collection of smaller subsidiaries that supply these products.
The company differentiates itself from other distributors by offering a value-added service. It provides bespoke solutions for its customers.
Growth for it comes from two sources. The first is acquiring new businesses to add to its network and the other is by growing its existing subsidiaries.
Over the last decade, this has proved a powerful combination. The firm has grown revenues at 15% per year and earnings per share at 11%.
Strong growth
The latest update indicates that things are going pretty well on both fronts. The headline is that revenues have grown 13% over the last nine months.
Around 10% of this has come from the company’s acquisitions and growth in existing businesses generated another 6%. Changes in exchange rates brought this down by 3% to 13% in total.
Diploma also reported the smooth integration of its latest acquisitions, including Peerless Fasteners from earlier this year. As a result, margins came in as expected.
The result was in line with management’s guidance for the year. And the company is forecasting similar growth in revenues, with earnings per share set to increase by 15%.
Growth and value
Diploma is a high-quality company. Its competitive position is difficult to disrupt and its ability to keep making acquisitions should give it scope to keep growing at a good rate in the future.
With this type of business, the biggest risk is often the possibility of overpaying for a subsidiary. This can be destructive to shareholder value.
Diploma’s management has an excellent record in this area, though. And I think it could be a while until the company finds itself in a position where it’s short of attractive opportunities.
In my view, the bigger issue is the fact the stock trades at a price-to-earnings (P/E) ratio of 49 (or 29 based on the adjusted EPS that Diploma measures in its updates). A great business can be worth a high price tag, but that is a lot to pay for any company.
A buying opportunity?
The Diploma share price is falling slightly after the latest news, but the stock is still up 39% over the last 12 months. The firm’s ability to keep growing has been impressive and I expect this to continue.
I used to own the stock in my portfolio, but I sold it just over a year ago at £28.18. The main reason was that I thought it was overvalued.
That’s proved to be a mistake, but I don’t think buying it back at £42.08 is the way to undo that. So I’m going to keep my eye on the shares but look for a better opportunity elsewhere for now.
