Shares in FTSE 100 distribution firm Diploma (LSE: DPLM) are up 42% from their 25 January 12-month £31.99 traded low. In the past few days though, they have dropped 2%, so is this a bargain-buy opportunity for me?
Why have the shares dipped?
The stock fell 7% on 19 November – the day of its full-year 2024 results release.
On the face of it, this looked bizarre, as the company’s revenue rose 14% year on year to £1.36bn. And its adjusted operating profit jumped 20% to £285m.
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However, the markets are an unforgiving place, and the revenue was marginally lower than analysts’ forecasts of £1.37bn. And the adjusted operating profit was ‘only’ in line with analysts’ projections.
In my view, these are marginal misses as most. I think the price fell simply because investors saw the year-end as a good time to take some profit.
Is there serious value here?
Just because the stock has risen 42% from its one-year traded high does not mean there is no value left in it.
The increase could have resulted from the business being fundamentally worth more than it was before. Or it may have been the market just catching up with the true worth of the shares. Indeed, it is possible that the stock’s price still does not reflect its full fair value.
To find out if this is true, I looked first at Diploma’s price-to-earnings ratio (P/E) compared to its closest competitors.
It trades at a P/E of 46.1 against a competitor average of 19.4. The group comprises Bunzl at 24, RS Group at 20.1, and Grafton Group at 14.1. So it looks very overvalued on this basis.
The same is true of its price-to-book ratio of 6.7 compared to the 3.1 average of its competitors. And it is also the most expensive on the price-to-sales ratio as well, at 4.4 against its competitors’ average of 1.
In sum, it is very overvalued on all the key comparative stock measures I have found most useful over the years.
How does the core business look?
Its 2024 results highlighted three new state-of-the-art facilities opened to support growth in the UK and Europe. These will make 10 such openings in the past five years.
Diploma also strengthened its balance sheet, with committed financial funding of £880m with maturities up to 2036.
For full-year 2025, it expects organic growth of around 6% and an operating margin of around 21%. Consensus analysts’ forecasts are that its earnings will grow 14.3% a year to end-2027.
The principal risk I see here is an economic slowdown in any of its key markets of the UK, Europe and the US. This would cause demand for its products to decline, especially those geared to the industrial sector.
Will I buy the stock?
Diploma’s earnings growth prospects look good to me. But I think the currently overvalued shares already reflect this projected expansion.
There are many other high-growth stocks available at significant discounts to their fair value, in my view.
The firm also only offers a dividend yield of 1.3%. My high-yield stocks currently return well over 8%, so it is not for me on this basis either.
