UK Edition
The FTSE 350 index is currently a buyers’ market. Even high-quality companies with excellent long-term growth prospects are trading at attractive prices.
Investors who can look beyond short-term economic challenges, such as high inflation and slow economic growth, therefore have the opportunity to generate significant returns over the long run.
After all, interest rates are expected to fall over the coming years as inflation moves below the Bank of England’s 2pc target. This alone is likely to provide a substantial catalyst not only to Britain’s economic growth, which is forecast to improve markedly as soon as next year, but also to today’s downbeat investor sentiment towards stock markets.
Companies that recognise the existence of today’s buyers’ market are also likely to perform well in future. Just like investors, they can capitalise on temporarily low asset valuations to bolster their long-term growth prospects in an improving economic environment.
Diploma, for example, is on a spending spree. The company, a supplier of specialist technical products such as gaskets, wiring and seals, invested £187m in seven acquisitions in the 2022 financial year. It subsequently spent a further £98m on eight company purchases in the first half of the 2023 financial year, while its latest acquisition, in July, amounted to £170m.
Those purchases boosted revenues by 8pc in the first nine months of the 2023 financial year, which is only slightly below the company’s 9pc organic growth rate in the same period. Encouragingly, it has a pipeline of potential acquisitions that amounts to around £1bn. This suggests it is likely to continue to capitalise on temporarily depressed asset prices to strengthen its competitive advantage and long-term growth potential.
Diploma’s competitive position is already extremely sound. In its 2022 financial year, for instance, its return on equity was 16pc.
It has a net gearing ratio of just 25pc of assets following a sale of new shares in March. This indicates that the company’s borrowings could materially increase to fund additional acquisitions without placing undue pressure on its balance sheet. Net interest cover of almost seven times in the first half of the 2023 financial year further evidences its solid financial standing.
In terms of profitability, the company’s recent third-quarter trading update confirmed that it expected to deliver a previously upgraded operating profit margin of 19pc for the full year. Alongside forecast sales growth of 14pc for the full year, the company’s financial performance is highly impressive even during a period of constrained global economic growth.
Indeed, its broad geographical exposure makes it well placed to benefit from an improving operating environment as the current era of restrictive global monetary policy gradually eases.
Although the world’s economic growth prospects are subdued on a short-term basis, history suggests they are likely to improve significantly as a period of more dovish monetary policy is implemented in response to long-term demographic changes across advanced economies.
In the near term, Diploma’s improving financial performance suggests that dividends should rise. After all, the company aims to increase shareholder payouts at a similar pace to earnings growth.
Following a rise of 79pc over the past two years, dividends look poised for a further substantial increase after the company produced earnings growth of 26pc in the first half of the 2023 financial year. The stock therefore offers far greater income appeal than its 1.8pc yield suggests.
Its valuation is also far more enticing than investors may realise.
It currently trades at 24 times forecast earnings. While this is undoubtedly high in the current buyers’ market, the company grew earnings per share by 26pc in the 2022 financial year and, as previously mentioned, matched this rate of growth in the first half of the 2023 financial year.
As a result, this column believes the stock offers good value for money.
It has already produced a 20pc capital gain and been promoted to the FTSE 100 index since we tipped it in October last year. With the financial means to make further acquisitions, a clear competitive advantage and the prospect of improving trading conditions, Diploma’s shares have further room to run. Keep buying.
Questor says: buy
Ticker: DPLM
Share price at close: £29.42
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