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Shares in Diploma (LSE:DPLM) are up 19% since the start of the year, making the FTSE 100 stock one of the best performers in the index. And this isn’t just hype – it’s a reflection of the underlying business.
When the price of a stock goes up, it can be easy to think that it isn’t a bargain any longer. But as Apple shareholders from 2009 will know, this can be a big mistake.
Rising share prices
At first sight, Diploma shares don’t look like a bargain. As well as being 19% more expensive than it was in Janaury, the stock trades at a price-to-earnings (P/E) multiple of 37 – way above than the FTSE 100 average.
Investors should think carefully before they decide the shares are overvalued, though. Writing off a stock because it has become more expensive can lead to some potentially costly missed opportunities.
In 2009, the Apple share price increased by over 100%. But investors who decided against buying the stock at the end of the year would have missed out on a huge 2,400% gain in the stock since then.
In other words, if I’d invested £1,000 in Apple shares at the end of 2009 – after the stock had gained more than 100% in 12 months – I’d have an investment today with a market value of £25,000. That’s a huge return.
I’m not saying Diploma is about to achieve those kinds of returns in the next few years. But I do think the fact the stock is up doesn’t automatically mean it isn’t going to be a great investment going forward.
Growth prospects
Diploma is a conglomerate made up of a number of smaller businesses specialising in industrial component distribution. That means it aims to grow in two ways.
One is by acquiring new businesses. Adding the income these acquisitions generate to its existing operations allows Diploma to increase its earnings over time.
The other is by helping its existing businesses operate more efficiently. This might involve boosting their scale, connecting them with new markets, or helping them exploit synergies with other Diploma companies.
With this type of company, the main risk is often overpaying for an acquisition. This can be a serious impediment to growth and investors need to hope that management can avoid doing this wherever possible.
It’s worth noting, though, that this often comes when companies reach a certain size. And Diploma’s £4.5bn market cap makes it relatively small, meaning it has a lot of room to grow before opportunities start to dry up.
Should investors consider buying Diploma shares?
A P/E ratio of 37 means investors will need to be patient with Diploma shares and wait for the company to grow into its valuation. But I think there’s every chance this will turn out to be a great investment at today’s prices.
I can’t think of a FTSE 100 stock I’d rather own in my portfolio right now. So even with an expensive price tag that is much higher than it was at the start of January, I’m thinking seriously about buying this FTSE 100 stock.
