diff --git a/homeassistant/components/esphome/manifest.json b/homeassistant/components/esphome/manifest.json
index 3e92f5a515c..b07e0f3a476 100644
--- a/homeassistant/components/esphome/manifest.json
+++ b/homeassistant/components/esphome/manifest.json
@@ -3,7 +3,7 @@
   "name": "ESPHome",
   "config_flow": true,
   "documentation": "https://www.home-assistant.io/integrations/esphome",
-  "requirements": ["aioesphomeapi==13.1.0", "esphome-dashboard-api==1.1"],
+  "requirements": ["aioesphomeapi==13.1.0", "esphome-dashboard-api==1.2.1"],
   "zeroconf": ["_esphomelib._tcp.local."],
   "dhcp": [{ "registered_devices": true }],
   "codeowners": ["@OttoWinter", "@jesserockz"],
diff --git a/homeassistant/components/esphome/update.py b/homeassistant/components/esphome/update.py
index aae2ab46f04..0f4836d0c66 100644
--- a/homeassistant/components/esphome/update.py
+++ b/homeassistant/components/esphome/update.py
@@ -1,7 +1,9 @@
 """Update platform for ESPHome."""
 from __future__ import annotations
 
-from typing import cast
+import asyncio
+import logging
+from typing import Any, cast
 
 from aioesphomeapi import DeviceInfo as ESPHomeDeviceInfo
 
@@ -22,6 +24,8 @@ from .dashboard import ESPHomeDashboard, async_get_dashboard
 from .domain_data import DomainData
 from .entry_data import RuntimeEntryData
 
+KEY_UPDATE_LOCK = "esphome_update_lock"
+
 
 async def async_setup_entry(
     hass: HomeAssistant,
@@ -64,7 +68,7 @@ class ESPHomeUpdateEntity(CoordinatorEntity[ESPHomeDashboard], UpdateEntity):
 
     _attr_has_entity_name = True
     _attr_device_class = UpdateDeviceClass.FIRMWARE
-    _attr_supported_features = UpdateEntityFeature.SPECIFIC_VERSION
+    _attr_supported_features = UpdateEntityFeature.INSTALL
     _attr_title = "ESPHome"
     _attr_name = "Firmware"
 
@@ -106,3 +110,22 @@ class ESPHomeUpdateEntity(CoordinatorEntity[ESPHomeDashboard], UpdateEntity):
     def release_url(self) -> str | None:
         """URL to the full release notes of the latest version available."""
         return "https://esphome.io/changelog/"
+
+    async def async_install(
+        self, version: str | None, backup: bool, **kwargs: Any
+    ) -> None:
+        """Install an update."""
+        async with self.hass.data.setdefault(KEY_UPDATE_LOCK, asyncio.Lock()):
+            device = self.coordinator.data.get(self._device_info.name)
+            assert device is not None
+            if not await self.coordinator.api.compile(device["configuration"]):
+                logging.getLogger(__name__).error(
+                    "Error compiling %s. Try again in ESPHome dashboard for error",
+                    device["configuration"],
+                )
+            if not await self.coordinator.api.upload(device["configuration"], "OTA"):
+                logging.getLogger(__name__).error(
+                    "Error OTA updating %s. Try again in ESPHome dashboard for error",
+                    device["configuration"],
+                )
+            await self.coordinator.async_request_refresh()
diff --git a/requirements_all.txt b/requirements_all.txt
index a36231aa96e..3753f1fd1a2 100644
--- a/requirements_all.txt
+++ b/requirements_all.txt
@@ -676,7 +676,7 @@ epson-projector==0.5.0
 epsonprinter==0.0.9
 
 # homeassistant.components.esphome
-esphome-dashboard-api==1.1
+esphome-dashboard-api==1.2.1
 
 # homeassistant.components.netgear_lte
 eternalegypt==0.0.12
diff --git a/requirements_test_all.txt b/requirements_test_all.txt
index bf09058933e..9c66ac244a1 100644
--- a/requirements_test_all.txt
+++ b/requirements_test_all.txt
@@ -526,7 +526,7 @@ ephem==4.1.2
 epson-projector==0.5.0
 
 # homeassistant.components.esphome
-esphome-dashboard-api==1.1
+esphome-dashboard-api==1.2.1
 
 # homeassistant.components.eufylife_ble
 eufylife_ble_client==0.1.7
diff --git a/tests/components/esphome/test_update.py b/tests/components/esphome/test_update.py
index 054ea92c9da..a263f4ab0cd 100644
--- a/tests/components/esphome/test_update.py
+++ b/tests/components/esphome/test_update.py
@@ -17,12 +17,23 @@ def stub_reconnect():
     "devices_payload,expected_state,expected_attributes",
     [
         (
-            [{"name": "test", "current_version": "1.2.3"}],
+            [
+                {
+                    "name": "test",
+                    "current_version": "1.2.3",
+                    "configuration": "test.yaml",
+                }
+            ],
             "on",
             {"latest_version": "1.2.3", "installed_version": "1.0.0"},
         ),
         (
-            [{"name": "test", "current_version": "1.0.0"}],
+            [
+                {
+                    "name": "test",
+                    "current_version": "1.0.0",
+                },
+            ],
             "off",
             {"latest_version": "1.0.0", "installed_version": "1.0.0"},
         ),
@@ -61,3 +72,24 @@ async def test_update_entity(
     assert state.state == expected_state
     for key, expected_value in expected_attributes.items():
         assert state.attributes.get(key) == expected_value
+
+    if expected_state != "on":
+        return
+
+    with patch(
+        "esphome_dashboard_api.ESPHomeDashboardAPI.compile", return_value=True
+    ) as mock_compile, patch(
+        "esphome_dashboard_api.ESPHomeDashboardAPI.upload", return_value=True
+    ) as mock_upload:
+        await hass.services.async_call(
+            "update",
+            "install",
+            {"entity_id": "update.none_firmware"},
+            blocking=True,
+        )
+
+    assert len(mock_compile.mock_calls) == 1
+    assert mock_compile.mock_calls[0][1][0] == "test.yaml"
+
+    assert len(mock_upload.mock_calls) == 1
+    assert mock_upload.mock_calls[0][1][0] == "test.yaml"