Journey from small-cap share to FTSE 100 in 12 years

The “secret sauce” at quality compounder Diploma (LSE:DPLM) is about to be discovered by blue-chip investors after the industrial supplier moved to the brink of the FTSE 100 today.

Diploma is now worth more than £4 billion, having delivered compound annual earnings growth of 15% over 15 years and 19% in the past three years.

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It is focused on the three sectors of seals, controls and life sciences, buying quality small and medium-sized businesses with the potential to deliver strong returns.

Diploma’s portfolio of businesses create the solutions that make customers’ lives easier, with the value created from this far in excess of the cost of the product.

Since chief executive Johnny Thomson took over in 2019, Diploma has doubled in size through organic growth and the acquisition of about 30 strategically important businesses.

The US now accounts for 45% of the group compared with 25% four years ago, including through Diploma’s largest-ever acquisition of Windy City Wire. The Chicago-based business, which makes premium quality, low voltage wire and cable, has tripled its profits and delivered returns of over 20% in its third year in the group.

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When he held a briefing for City investors in June, Thompson described Diploma's value-add business model as the company’s key differentiator.

He explained: “We’re a service business as much as a distribution business. And, while we do some light assembly, we’re not a manufacturer. Our products are specialised and always with a customer service wrapper too.”

Thompson also highlighted the company’s decentralised culture that preserves local ownership but with an alignment to group objectives. A lean structure means there’s only 25 Diploma head office roles.

He calls this differentiated decentralised culture “our secret sauce”, all while enjoying the benefits of a big group. “We call it the Diploma Identity – creating leadership networks, collaboration and best practice sharing. We become more than the sum of our parts.”

The strategy means the shares have more than doubled since the early days of the pandemic, momentum that means the company is expected to join the top flight in September’s reshuffle based on tonight’s closing prices. It joined the FTSE 250 index in October 2011 when the share price was around 320p.

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The shares today stood at 3,140p but analysts at Jefferies believe there’s the potential to reach 3,400p after recently upgrading their price target by 14%.

Once surplus capital is deployed on acquisitions, the bank said Diploma drops to the bottom quartile of its historic valuation range of 18-25 times forward earnings. “We believe this valuation is too low if M&A continues to create value.”

Numis Securities, which has a target price of 3,700p, recently highlighted Diploma’s growing end markets and deeper penetration of large developed regions. It said: “We believe Diploma offers exceptional compounding structural growth opportunities.”

The company’s largest division of controls supplies specialised wiring, cables, connectors, fasteners and adhesives for technically demanding applications.

The seals sector businesses supply a range of seals, gaskets, cylinders, components and kits used in heavy mobile machinery, while the smaller life sciences arm provides equipment, consumables and instrumentation to the healthcare industry.