Despite strong results and solid earnings growth forecasts, this FTSE high-flyer looks overvalued to me
FTSE 100 technical products and service distributor Diploma (LSE: DPLM) hit a record high of £50.20 on 20 May. This marked a 169% rise from its opening price of £18.65 on 4 June 2020.
It is not surprising, as the firm has posted broadly strong results over the period, including its H1 2025 numbers.
However, such a rise is no reason to avoid buying a stock, fearing that it cannot possibly increase much further. But neither does it mean it should be bought on expectations of continued unstoppable bullish momentum.
The key question in my experience as a former senior investment bank trader and longtime private investor is if any value remains.
I took a closer look at Diploma to try to find out what the truth is here.
The latest figures
Its H1 2025 results released on 20 May saw organic revenue growth of 9% year on year to £728.5m.
Adjusted operating profit jumped 25% to £156.9m, while free cash flow rose 26% to £83.8m. Adjusted earnings per share leapt 23% to 80.2p.
The firm upgraded its 2025 guidance to 8% organic revenue growth from 6%, and to an operating margin of 22% from 21%.
Consensus analysts’ forecasts are that its earnings will increase by 9% a year to the end of 2027.
Revenue is the total income a firm generates, while earnings are what remain after expenses are deducted.
All in all then, a very strong set of numbers, no doubt. Having said that, I will not pay any price for shares in a good, or even great, firm.
Instead, I will look at how its current price compares to the fair value per share of the underlying business.
The value proposition
The difference between price and value can be pinpointed by running a discounted cash flow (DCF) analysis. It identifies where any firm’s share price should be, based on cash flow forecasts for the firm.
Using other analysts’ figures and my own, the DCF for Diploma shows its shares are 43% overvalued at £46.25.
Therefore, their fair value is technically £32.53.
This view is also echoed in the stock’s key valuations compared to its competitors. Its 37.5 price-to-earnings ratio is vastly overvalued against its peers’ average of 15.5.
The same is true of its 6.7 price-to-book ratio against its 2 average of its competitors. And it is also the case with Diploma’s 4.3 price-to-sales ratio compared to its peer average of 0.8.
There is little additional compensation for holding the stock from its dividend yield either. This currently stands at 1.3% compared to the present FTSE 100 average of 3.5%.
My view
I believe Diploma is a solid company that will see good earnings growth in the next few years.
However, I think the market has already factored all of that – and more – into the share price before it has happened. This is the key risk in the shares to me.
It means that the stock is not an investment based on its price converging with its fair value over time.
Instead, I happen to think it is a gamble on whether the fair value can eventually catch up with the price.
As this runs contrary to all my investment experience over the years, I will not buy it.
The post Despite strong results and solid earnings growth forecasts, this FTSE high-flyer looks overvalued to me appeared first on The Motley Fool UK.
Like buying £1 for 31p
This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!
Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.
What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?
More reading
- 3 FTSE 100 shares that could help propel the index higher
- As huge earnings send the Diploma share price up 15%, what should investors do?
Simon Watkins has no position in any of the shares mentioned. The Motley Fool UK has recommended Diploma Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
