Trading Strategies: FTSE 100 high-flyer backed to keep outperforming

The FTSE 100’s surge to a price level in excess of 9,000 points has understandably dominated headlines over recent days. After all, it represents a record high for the UK’s major index. Furthermore, it means that, despite previous investor complaints about the poor performance of UK-listed large-cap stocks, their overall returns have been encouraging over the long run.

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Indeed, the FTSE 100 has produced an annualised capital gain of around 5.4% since its inception in January 1984. When dividends are added to that figure, it equates to an annualised total return that is firmly in the high single digits.

High volatility

Generating those returns, of course, has proved to be anything but plain sailing. The FTSE 100 has experienced a vast array of challenges over the past 41-plus years that have prompted numerous downturns, corrections and bear markets. For example, the bursting of the dotcom bubble in the early 2000s, the global financial crisis in the late 2000s and the Covid-19 pandemic during the early 2020s have each caused severe declines in share prices.

Even when the index is in the midst of a bull market, it can still exhibit extreme volatility. This year, for example, the FTSE 100 has made several all-time highs on its way to the record 9,000 points level. Yet in early April it suffered an 11% slump in a matter of days when President Donald Trump announced so-called Liberation Day tariffs that were far more extreme than many investors had previously anticipated.

Buy-and-hold strategy

Since early April, the FTSE 100 has clearly produced an exceptional recovery. But many investors are likely to have missed out on its recent gains, as well as its impressive total return performance in previous years, following the aforementioned downturns, corrections and bear markets that have occurred since the index’s inception. Indeed, many investors appear to struggle to come to terms with the inherent volatility of the stock market. For this reason, purchasing bonds or holding cash can seem to be an appealing solution given their relatively stable prices.

Crucially, though, high volatility in itself does not equate to a greater risk of permanent capital loss. After all, short-term share price movements are overwhelmingly influenced by investor sentiment towards specific companies, industries and the wider economy. In many cases, investors are highly emotional and can quickly change their minds on the outlook, thereby prompting a period of elevated share price volatility that is not necessarily reflective of a decline in the financial standing of specific companies.

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Certainly, falling share prices mean investors will inevitably experience paper losses on their holdings for a period of time. But if their positions are not sold during such periods, history suggests that the stock market will recover over the long run. This means that a buy-and-hold strategy has a relatively high chance of ultimately producing positive total returns.

Sound fundamentals

Buying high-quality companies could also reduce the risk of a permanent loss of capital. For example, firms that have modest debt levels and can easily afford to service existing borrowings are more likely to successfully overcome periods of economic difficulty which negatively affect their financial performance.

Similarly, companies that have a competitive advantage, such as via lower costs than their rivals or due to a high degree of brand loyalty among their customers, may not suffer financially to the same extent as their peers during severe economic downturns.

Such companies, of course, are still extremely likely to experience elevated share price volatility at times. Given the FTSE 100’s past performance, though, it could easily be argued that periods of extreme volatility are a price well worth paying for high long-term returns relative to other mainstream assets.

Strong performance

Source: ShareScope on 24 July 2025. Past performance is not a guide to future performance.

Given the FTSE 100’s surge to a record high of over 9,000 points, it is perhaps unsurprising that several of its members also trade at or close to all-time highs. Among them is Diploma (LSE:DPLM), which produces a variety of highly specialist products such as seals, cabling and fasteners to a wide range of end markets. Its share price has risen by 20% since it was first discussed in this column during July last year. Over the same period, the FTSE 100 has risen by around 11%. I mentioned it again in March at 3,974p, since when it has risen 31% versus 5.4% for the FTSE 100.

The company’s shares, of course, have been highly volatile over recent months. Notably, they were negatively affected by Trump’s Liberation Day tariffs. This, alongside an uncertain near-term outlook for the global economy, contributed to a 24% decline in the firm’s market valuation between mid-February and early April of this year.

Although they have clearly more than fully recovered since then, it would be unsurprising for the company’s shares to remain relatively volatile in future. After all, the global trade war could spring back into life following the recent end of the 90-day pause. Given Diploma’s status as a cyclical firm, increasingly protectionist trade policies implemented by the US could have a negative effect on global economic growth and investor sentiment towards the firm’s shares.

A high-quality business

Despite this, the company appears to still offer long-term capital growth potential. It is fundamentally sound, with a net debt-to-equity ratio of 56% and net interest cover of 10.6 in its latest financial year. These figures suggest it is well placed to overcome future periods of economic difficulty. A solid balance sheet also means it can engage in M&A activity, as demonstrated by the £39 million spent on two acquisitions during its latest quarter.

In addition, the firm’s return on equity amounted to 22% last year. This suggests it has a competitive advantage that could prove highly beneficial during both boom and bust periods alike. Moreover, Diploma’s latest trading update showed that it is on track to deliver a further improvement in its operating profit margin in the current year. Having risen by 120 basis points to 20.9% last year, it is set to rise by a further 110 basis points to 22% this year. This suggests that the company’s competitive position continues to improve.

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The firm’s third-quarter trading update also included an upgrade to its financial forecasts for the current year. It now expects organic revenue growth to amount to 10%, versus previous guidance of 8%. When the impact of acquisitions is included, the company’s top line increased by a relatively brisk 12% in the first nine months of the current financial year.

A premium valuation

Having surged over recent months to a record high, it is perhaps unsurprising that shares in Diploma now trade on a relatively rich earnings multiple. Indeed, the stock’s price/earnings ratio stands at 35.1 on current earnings, or less than 30 on forecast earnings. This is high both in absolute terms and also relative to the wider FTSE 100 – even at a time when the index trades at its highest ever level.

However, given that the firm has a solid balance sheet and a strong competitive position, it appears to be a high-quality business that is worthy of a premium valuation versus its large-cap index peers. Certainly, it could exhibit elevated share price volatility at times in future. But with solid fundamentals, it appears to be well placed to deliver further index outperformance over the long run.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.