I’d buy 1,858 shares of this UK stock for £1,000 in annual passive income

If I was looking for £1,000 a year in passive income, I would buy shares diploma (LSE: DPLM). At FTSE 250 The stock is not an obvious choice, with a dividend yield of just 1.95%.

That is lower than the interest rate I can get from my current savings account. But in the long run, I think Diploma shares could be a good investment.

return on investment

At current prices, I would need 1,858 Diploma shares for £1,000 of passive income. That required an initial investment of just over £51,700.

That’s a lot of money to put into one stock and I’m not in a position to do it right now. But I expect the stock to return more than £1,000 a year going forward.

Over the past five years, Diploma Corporation paid a 16.5% dividend per last share and an annual dividend yield of 16.5%. If it continues to do this in the future, then the potential returns for investors could be huge.

After five years of 16.5% annual growth, an investment of £51,700 will pay dividends of £1,900 per year. That’s almost double the current yield.

Generate potential to be more attractive looking ahead. With 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, a Diploma may not be an obvious choice for passive income these days. But that could pay big dividends if it can maintain its current growth rate.

Growth

The big question is how long the company can increase its dividend by 16.5% per year. Dividend income is never guaranteed, but I think there is reason for optimism here.

Diploma is a small business collection. This means trying to increase your income in two ways – by earning more with your existing business, or by acquiring a new one.

The company’s recent impressive growth is the result of acquisitions. Moving forward, I expect acquisitions to account for more and more of Diploma’s growth.

With this type of business, there is always a 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 noted that Berkshire HathawayIts size makes it difficult to find acquisitions large enough to help the company grow.

Diploma is about 0.5% of Berkshire’s size. That gives you greater opportunities when it comes to acquisitions.

Second, the company’s management has a good track record of conducting acquisitions with discipline. And continue in 2022.

In the first half of the year, Diploma acquired three businesses at an average of less than 10 times earnings. For context, the stock itself trades at an earnings multiple of around 25.

Dividend growth

Diploma dividends do not immediately jump as attractive. But I think the company’s growth prospects mean it can generate big returns in the future.

I have a Diploma in Stocks and Shares ISA, and I would like to increase my investment in the future.