Diploma PLC's (LON:DPLM) Stock Is Going Strong: Is the Market Following Fundamentals?

Diploma's (LON:DPLM) stock is up by a considerable 15% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Diploma's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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How Is ROE Calculated?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Diploma is:

18% = UK£168m ÷ UK£948m (Based on the trailing twelve months to March 2025).

The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.18 in profit.

See our latest analysis for Diploma

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Diploma's Earnings Growth And 18% ROE

To begin with, Diploma seems to have a respectable ROE. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. This certainly adds some context to Diploma's exceptional 23% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Diploma's growth is quite high when compared to the industry average growth of 8.7% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Diploma's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Diploma Efficiently Re-investing Its Profits?

Diploma has a significant three-year median payout ratio of 64%, meaning the company only retains 36% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Besides, Diploma has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 35% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we are quite pleased with Diploma's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.