Diploma: a blue-chip set for strong growth

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A small number of British firms have achieved sustained profitable growth using a combination of organic growth and bolt-on acquisitions, which are then developed much further. Diploma (LSE: DPLM) is a good example. I first recommended Diploma in MoneyWeek in April 2019, when the shares stood at 1,550p. That article pointed out that the share price had risen two-and-a-half times from 608p in autumn 2015 and suggested that there was plenty of potential for further growth.

This duly occurred: the recent share price is 4,140p, so the shares have risen almost threefold in just over five years, or nearly 22% per year with annual dividends on top of that. Diploma is a company in the FTSE 100 index with a market value of around £5.6 billion and 2023 turnover of £1.2 billion. The firm offers plenty of scope for further growth, with revenue up 52% between 2021 and 2023. Its three divisions all aim to achieve market-leading positions in their niches.

Diploma’s three arms are life sciences (comprising 17% of sales), seals (37%) and controls (45%). They all provide products coupled with services. These products and associated services are critical to customers, but of relatively low cost, so they are purchased from clients’ operating rather than capital budgets. Controls includes specialised fasteners (for aerospace, for instance) and adhesives; seals includes components and fittings for pneumatic pumps – both stock and custom-made, and often for mission-critical applications; life sciences includes technology-enabled products for surgery and endoscopy, along with diagnostic equipment for clinical laboratories and food safety testing.

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Diploma's acquisitions drive profits

Diploma has a strong mergers-and-acquisitions (M&A) pipeline diversified by sector, size and geography. The firm made six acquisitions worth a total of £284 million in the first half of the year to 31 March 2024. This sum exceeded the total seen in the two full previous financial years. The largest purchase this year was America’s Peerless Aerospace Fasteners for £236 million. It will accelerate organic growth through product and geographical expansion and should add 8% to Diploma’s earnings per share (EPS) in the year after the takeover. The second-biggest acquisition was UK-based Plastics & Rubber Group Holdings (PAR) for £38 million. It will add scale to the seals-and-gaskets activities and deliver an additional 1% of EPS.

Both Peerless and PAR are founder-owned businesses with great records of organic growth and business models that match Diploma’s strategy of building high-quality businesses for sustainable organic growth. Diploma operates a decentralised business model that encourages entrepreneurship and focuses on core, scalable business lines that can be developed with organic growth supplemented by bolt-on acquisitions.

This strategy has driven the company’s profitable growth, with revenue more than doubling to £1.2 billion between 2020 and 2023, operating profit rising by 2.6 times over that period and the dividend climbing from 20.5p to 55.3p a share. Diploma serves a diversified set of growing markets, including clinical diagnostics, electrification, industrial automation, infrastructure, renewables, water management, energy and civil aerospace. This tempers the impact of a slowdown in any one market.

Diploma uses return on adjusted trading capital employed (ROATCE) as a key financial measure, which is more demanding than the usual gauge of profitability, return on capital employed (ROCE). ROATCE is the pre-tax return on total capital – fixed and working plus intangibles and goodwill, including goodwill previously written off against retained earnings. ROATCE, therefore, covers capital spent on acquisitions. Diploma’s average ROATCE for the past five years has been 19%.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Highly qualified (BSc PhD CPhys FInstP MIoD) expert in R&D management, business improvement and investment analysis, Dr Mike Tubbs worked for decades on the 'inside' of corporate giants such as Xerox, Battelle and Lucas. Working in the research and development departments, he learnt what became the key to his investing; knowledge which gave him a unique perspective on the stock markets.

Dr Tubbs went on to create the R&D Scorecard which was presented annually to the Department of Trade & Industry and the European Commission. It was a guide for European businesses on how to improve prospects using correctly applied research and development.

He has been a contributor to MoneyWeek for many years, with a particular focus on R&D-driven growth companies.