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When viewing FTSE 100 stocks to consider buying, it sometimes pays to look beyond the obvious big names.
Diploma (LSE: DPLM) is a brilliant example. It’s delivered a total return of 508.8% over the last 10 years, new figures from AJ Bell show. That would have turned a £10,000 investment into £60,880. Yet it doesn’t get anything like the attention of, say, Rolls-Royce.
The shares are so rewarding
Diploma’s a specialist distributor of technical products that joined the FTSE 100 in 2023. It focuses on niche markets where competition’s limited, using both acquisitions and expansion of its existing portfolio to keep growing.
It’s a brilliant dividend stock, although investors wouldn’t know by looking at the modest trailing 1.1% yield. That’s a fraction of the 3.25% FTSE 100 average. Yet that’s not necessarily a weakness.
AJ Bell points out that a sky-high dividend can mask weakness elsewhere, as sceptical investors demand higher income to compensate for lower growth prospects. It argues that a track record of long-term dividend growth is “the real nectar for a share price”. Diploma has hiked shareholder payouts every single year this millennium.
Power of rising shareholder payouts
Over the last decade, Diploma’s raised its annual payout at an average rate of 13.3% a year. This helps explain why this relatively low-yield stock has outperformed so strongly. Its most recent trading update, covering the nine months to June, showed revenues up 12%. The board raised its full-year forecast to 10%.
The shares continue to power upwards, climbing 20% in the last year. My concern is that the valuation has now run way ahead of itself. The price-to-earnings ratio now stands at a dizzying 56. For context, 15 is often seen as fair value. Rolls-Royce, which has grabbed all the headlines, trades at 55 times. At those levels, even a slight stumble could send Diploma’s price lower.
I have another concern. Forecasts suggest dividend growth will slow to around 5% a year in 2025 and 2026. I imagine the dividends will come through, but they won’t grow as fast. And there’s another issue. With a market-cap of £7.25bn, Diploma will struggle to grow like it did when it was a smaller FTSE 250 stock.
Caution signs
There are other risks to weigh up. Diploma imports a lot of specialist components and could be hit by tariffs. Some of the recent strength in sales may also have come from customers building inventories ahead of potential cost increases. If that proves temporary, results could dip.
Stock analysts are cautious. The consensus one-year price target’s 5,535p, implying growth of just 2.33% from today. After such a powerful run, that doesn’t surprise me.
Diploma’s a great company but I won’t consider buying it at today’s toppy valuation. Instead, I’m tempted to look for other FTSE 250 stocks with the same dividend growth potential, and try to catch them earlier in their journey. That, I think, is the smarter way to hunt for the next long-term winner.
