When a stock goes down despite the underlying business making more money, there’s usually better value on offer for investors. That’s the case with Diploma (LSE:DPLM) after the company released its annual results on Tuesday (19 November).
Revenues were up 14% over the last year and earnings per share climbed 15%. But with the stock falling almost 7%, is this a rare opportunity for me to buy one of the FTSE 100’s best growth stocks?
Why is the stock falling?
If the company is doing so well, why is the stock going down? As I see it, there are two main reasons.
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To start with, while 14% revenue growth is impressive, it’s not that high in the context of Diploma’s recent performance. Since 2019, sales have been growing at an average of 21% per year.
That means the business actually grew more slowly in 2024 than it had done before. And the risk of that continuing is significant for a stock trading at a price-to-earnings (P/E) ratio of around 31.
Furthermore, the majority of that growth – 10% or so – came from acquisitions. That implies future growth depends on Diploma finding more acquisition tragets in future, which isn’t guaranteed.
Growth
Nonetheless, I see Diploma as a quality operation. And I think it’s competitive position gives it a good chance to grow at a decent rate for the long term.
The firm’s big advantages are twofold. First and foremost, it isn’t an ordinary distributor – it has several ways of adding value for customers.
These include maintaining a large inventory to be able to deliver products quickly and working with customers to provide a bespoke service. This sets the company apart from its rivals.
The more it grows, the bigger this advantage becomes. But this isn’t the only reason for shareholders to be optimistic in the future.
Acquisition risk
Growing through acquisition is risky because opportunities might run out or the company might over pay for them. But in both cases, Diploma has a degree of protection against this.
I think the FTSE 100 company struggling to find opportunities any time soon is unlikely. That might be an issue for Warren Buffett, but Diploma has a market cap of £5.6bn.
That means there shouldn’t be a shortage of businesses big enough to be worth considering. And from there, it’s a matter of not paying too much to acquire them.
The company’s ability to grow the businesses it buys is an important strength here. If Diploma can increase a firm’s earnings, this gives it scope to pay a higher multiple while limiting the chance of future impairments.
Time to buy?
Despite revenue growth slowing, Diploma is a quality growth stock. And the falling share price might just be the opportunity I’ve been waiting for to make a move on it.
At the very least, I’d say it’s worth a closer look. Since I can’t buy a stock within two days of writing about it, I’ve got a bit more thinking time, but if it heads any lower, I’ll be looking to buy it.
