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If you were looking for £1,000 per year in passive income, you would buy shares in Diploma (LSE: DPLM). He FTSE 250 Stocks are not an obvious choice, with a dividend yield of just 1.95%.
That’s lower than the interest rate you might get from a savings account right now. But long term, I think Diploma stock could be a great investment.
investment returns
At today’s prices, you would need 1,858 Diploma shares for £1,000 in passive income. That would require an initial investment of just over £51,700.
That’s a lot of money to invest in a single stock, and I’m not in a position to do it right now. But I would expect the shares to generate much more than £1,000 per year in the future.
During the last five years, Diploma has been increasing its dividend at a rate of 16.5% per year. If it continues to do this in the future, the potential benefits for investors could be enormous.
After five years of 16.5% annual growth, a £51,700 investment would be paying £1,900 a year in dividends. That’s almost twice the current performance.
The potential returns become even more attractive going forward. At the same growth rate, my annual passive income would be £4,400 after 10 years, £9,900 after 15 years, and £22,700 after 20 years.
In other words, Diploma might not be an obvious choice for passive income right now. But it’s one that can pay big dividends if it can maintain its current growth rate.
Growth
The big question is how long the company can keep increasing its dividend to 16.5% per year. Dividend income is never guaranteed, but I think there is reason for optimism here.
Diploma is a collection of small businesses. That means you try to increase your profits in two ways: by earning more from your existing businesses or by acquiring new ones.
The company’s impressive growth recently has been the result of its acquisitions. Going forward, I expect acquisitions to increasingly account for Diploma’s growth.
With this type of business, there is always the risk of damaging the balance sheet by paying too much for an acquisition. But there are two main reasons why I think this is unlikely to be a problem for Diploma.
The first is that Diploma is still a fairly small company. Warren Buffett points out that Berkshire HathawayThe size of makes it difficult to find acquisitions large enough to help the company grow.
Diploma is about 0.5% the size of Berkshire. That gives you a much greater set of opportunities when it comes to making acquisitions.
The second is that the company’s management has a good track record of disciplined acquisitions. And that has continued into 2022.
In the first half of the year, Diploma acquired three businesses paying an average of less than 10 times earnings. For context, its own shares are trading at an earnings multiple of around 25.
dividend growth
Diploma’s dividend is not immediately attractive. But I think that the company’s growth prospects mean that it could generate big profits in the future.
I own Diploma shares in my Stocks and Shares ISA, and am looking to add to my investment in the near future.
