Diploma - a Magic Formula company

Diploma (LON:DPL) (website) operates in the following ares: life sciences - supplying a range of consumables, instrumentation and related services to the healthcare and environmental industries; seals - supplying hydraulic seals, gaskets, cylinders, components and kits used in heavy machinery; controls - supplying specialised wiring, connectors, fasteners and control devices At a price of 328p (£372 market cap), it trades at a PER of 15.2, a yield of 3.0%, and a PBV of 2.7. It has a very solid balance sheet, with a z-score of 6.4, non-current liabilities at only half last year's net profit, and a gearing of -22% (negative gearing). Analysts estimate an EPS growth of 24% for 2011, and further growth of 10% for 2012. Median ROE for the last decade was 15%, which co-incides with the current ROE for the latest reported full figures. All good signs, in my opinion.

In a recent trading statement, the directors noted a strong increase in revenues and profitability in the first quarter of trading, which has continued into a second quarter, and expect that the adjusted profit before tax for the year ending September 2011 will be materially ahead of the market consensus of £36m.  Directors have been making purchases to the tune of £69k in March, and £90k in February.

Diploma is also appearing high on my Magic Formula screen. I use Sharelock Holmes to produce a "Greenblatt Ranking" (which is Sharelock's calculation of the Magic Formula score) for companies with a market cap of over £300m. Investment Trusts are excluded. This returns a list just short of 400 companies. A company in the top 40 is worthy of further investigation, in my opinion. Diploma meets such a test, possessing a high return on capital, and an "earnings yield" (actually more like EBIT/EV) of 10%. It is difficult to know, for sure, how closely the Sharelock Holmes results would match the actual rankings if they were produced by Greenblatt, but judging by the glossary on the Sharelock websites, it would seem that the results are likely to be "close enough". Diploma thus qualifies as a "cheap and good" company.

For those that like a little bit of momentum behind the share price, Diploma has a relative 6-month strength of 7% (i.e. it outperformed the market by 7% over 6 months), and a relative strength of 56% over a 12-month period.

On the downside, Interactive Investor blogger Richard Beddard recently estimated a fair value for Diploma of 200p using a residual income model with 5-year projections. The webpage contains a detailed explanation of the methodology used, and was praised by Steven Baines, a professional investment analyst. Richard produced a revised valuation of 480p yesterday (no, it wasn't an April Fool's joke), but the model was based on 10-year projections instead of 5. The RIM he used calculates quite conservative carrying values, so extending the forecasting horizon has the effect of upping the intrinsic value.

Conclusion: Diploma (LON:DPLM) is a magic formula company with a solid balance sheet, good returns on capital, and is available at a reasonable price. You even get a divvie out of it. The outlook for the company is good, and recent director purchases bolster this bullishness.

Disclosure: I own shares in Diploma (I never take short positions).