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Every time I think I’ve missed my chance to buy shares in Diploma (LSE:DPLM), I get a surprise. And the FTSE 100 stock’s up 8% this week after yet another strong trading update.
The share price reflects high expectations. But that’s been the case for a long time and the firm has consistently found ways to impress the stock market.
Competitive position
Diploma’s a collection of businesses focused on distributing industrial components. Its key strengths are its scale, specialist expertise, and huge product range.
These make it very difficult to disrupt. For manufacturers, setting up the required distribution network to go directly to customers would be expensive and difficult.
For end users, Diploma provides convenience and speed. When a repair shop needs a part for a machine, the company is the most likely one to have it in stock and be able to deliver in a hurry.
Scale advantage in relatively stable industries can be a big advantage. And the FTSE 100 company has done an outstanding job of demonstrating this over the last decade, or so.
Results
It has two main strategies when it comes to growth. The first involves acquiring other businesses to improve its reach and range and the second is expanding its existing subsidiaries.
In general, the stock market likes it better when the firm’s growth comes from its existing operations. Acquisitions are typically seen as more risky – and there’s some justification for this.
In this context, the latest update’s very strong. In the nine months leading up to the end of June, Diploma’s revenues grew 12% – 10% from existing operations and 4% from acquisitions.
A 2% currency shift set that back, but the result is strong both in terms of how much sales are growing and where that growth is coming from. And the firm raised its full-year forecast to 10%.
Tariffs
Diploma’s increased guidance is impressive, but I think investors would be unwise to ignore the threat of tariffs. The firm imports a lot of specialist components in several countries.
In the short term, companies might try to build inventories ahead of potential cost increases. But if this is the case, investors should expect the effect to reverse eventually.
That means Diploma’s impressive results might be driven by some unusually strong demand that’s going to prove temporary in nature. And this is something to pay attention to.
If that’s the case, investors might find a better opportunity to consider the stock in the near future. But over the last five years, chances to pick up shares at low multiples have been few and far between.
Is now the time?
I came close to buying the stock in April, when the share price hit £36. But I ultimately opted for Bunzl, which I think trades at a more attractive valuation, despite bigger short-term challenges.
I don’t regret that choice, but there’s no question Diploma shares have fared better in the last three months. However, that’s in the past – what matters now is the current share price.
Ultimately, the question is whether 10% sales growth justifies a free cash flow multiple of 33. I think it’s a very close call, but that puts it on my list of stocks to watch, rather than buy.
