- Distributor’s first-half earnings show power of its business model
- Select acquisitions supplement organic momentum, rather than try to create it afresh
- Interim increase in dividend readies firm to extend annual payment growth streak
“It is easy to see why shares in distributor Diploma are up nicely after the release of its first-half results and even setting new all-time highs,” says AJ Bell investment director Russ Mould. “The results show the power of a business model whereby Diploma provides products without which its customers would struggle to operate and how careful use of acquisitions can supplement the momentum that exists within a company (rather than taking the risk of big deals that bet the farm in the attempt to conjure up growth from nowhere). Best of all, these two attributes combine to produce the healthy margins and cash flow that fund dividend payments and the 5% increase in the first-half payment puts the FTSE 100 firm well on the way to a twenty-fourth consecutive hike in the annual distribution.
Source: Company accounts, Marketscreener, consensus analysts' estimates
“This is a good example of the power of dividend growth. History suggests that it is not the highest-yielding stocks which prove to be the best long-term investments anyway (even if the past is by no means a guide to the future).
“Often defending a high yield can be a burden for a firm, as it sucks cash away from vital investment in the underlying business or can be a sign that the company is in trouble and investors are demanding such a high yield to compensate themselves for the (perceived) risks associated with owning the equity.
“The strongest long-term performance often comes from those firms that have the best long-term dividend growth record, as they provide the dream combination of higher dividends and a higher share price – the increased distribution can over time drag the share price higher through sheer force. A 1p per share dividend on a 100p share price may not catch the eye, but if that dividend reaches 10p in a decade’s time it almost certainly will, all other things being equal.
“The ravages of the pandemic and the recession have taken their toll on the ranks of FTSE 100 firms that can point to a ten-year dividend growth history.
“That number now stands at seventeen and, in aggregate, their share price performance, and the total returns generated for stockholders, stand head and shoulders above those provided by the wider FTSE 100, even if the index is finally setting new all-time highs.
“The average capital gain from the seventeen ten-year dividend growers over the past decade is 220% and the average total return is 319%.
“Both easily beat the FTSE 100, at 24% and 78% respectively, over the last ten years.
Source: Company accounts, Marketscreener, consensus analysts’ forecasts
“However, the strategy is not infallible, and it is one best-suited to a long-term time horizon.
“The charms of these seventeen names are now well understood and they often fall into the ‘quality’ bucket of many portfolios, where investors seek out strong franchises that are capable of providing steadily compounding returns over time.
“But even ‘quality’ does not guarantee safety if the valuation paid to access the cash flow and dividend streams is too high.
“Some of the seventeen stocks suffered a bit of a reckoning in 2022 and 2023, especially as many had begun to trade on valuations which represented a huge premium to the FTSE 100, at least on an earnings basis. Higher interest rates did not help much either, as the higher discount rates implied by the increased cost of money meant that the net present value of future cash flows went down in discounted cash flow models (DCFs) and took the theoretical value of the equity with it.
“Higher confidence in the economic outlook could also tempt investors to look for cheaper, cyclical earnings growth rather than more expensive, reliable, secular profit increases, so careful research is therefore still required because no single investment strategy can work all of the time.
“It is also worth bearing in mind that only nine of the seventeen were members of the FTSE 100 a decade ago.
“Diploma, along with DCC, Foreign & Colonial Investment Trust, Halma, Hikma, Intermediate Capital, Scottish Mortgage and Spirax-Sarco were not constituents of the UK’s premier index in 2014, so investors might need to dig around in the realms of the mid- and small-caps to find at least some of the next generation of serial dividend growers.”
