Why Diageo plc Should Be A Candidate For Your 2014 ISA

Diageo plc (LON: SBRY) has had a great five years, and there’s more to come.

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diageoDiageo (LSE: DGE) (NYSE: DEO) looks like its earning growth could falter a little this year and next, its shares are not a screaming bargain in terms of its P/E ratio, and its dividend is yielding less than average at around 2.7%, based on today’s share price of 1,859p.

But I still think it’s a worthy candidate for your ISA.

Forget current valuation

With a new allowance of £11,760 coming our way in April, and with many still left with some of this year’s allowance still unused, we need to find good shares for it. For me, current valuation means little when it comes to an ISA — I reckon it’s perfect for a decades-long horizon, and I look for shares that I think will still be doing well 20 years from now.

So what’s Diageo’s slightly-longer record looking like? Here’s its past five years of headlines, coupled with forecasts for the next two:

Jun EPS Change P/E Dividend Change Yield Cover
2009 69.7p +8% 12.5 36.1p 4.1% 1.9x
2010 72.0p +3% 14.7 38.1p +5.5% 3.6% 1.9x
2011 83.6p +16% 15.2 40.4p +6.0% 3.2% 2.1x
2012 94.2p +13% 17.4 43.5p +7.7% 2.6% 2.2x
2013 104.4p +11% 18.0 47.4p +9.0% 2.5% 2.2x
2014* 102.4p -2% 18.3 51.1p +8.6% 2.7% 2.0x
2015* 111.8p +9% 16.8 55.4p +8.4% 2.9% 2.0x

* forecast

What are we looking at there? Well, the key thing for me is those steadily-rising dividends — forget the yield for now, and just look at those annual percentage increases that massively outpace inflation.

Sound cash management

What Diageo sensibly did was keep its dividend rises below its rate of annual earnings growth when the going was very good, leaving it with the ability to keep those dividend rises going even when we’re faced with a year or two of slowing growth. In fact, at the halfway stage this year Diageo boosted its interim dividend by 9%, lending confidence to those forecasts for the full year.

And despite analysts expecting a small fall in earnings in 2014, the drinks giant told us that operating profit for the first six months rose by 2.9% with pre-exceptional earnings per share up 4%.

Strength through diversity

Sales in all categories other than beer experienced rises — and beer only fell by 2.6%, due to weakness in Nigeria and Ireland. Overall net sales in Western Europe fell 1%, but North American sales gained 4.6% with emerging market sales up 1.3%.

That hints at one of Diageo’s key strengths — its international diversity.

Another is its brand portfolio — Diageo is the company behind such market leaders as Johnnie Walker (breakfast of champions), Moët & Chandon, Bushmills, Smirnoff, Gordon’s gin, Bundaberg rum, Haig, Veuve Cliquot, Hennessey… and who could forget Rumple Minze and Sirop de Picon?

What’s it worth?

If we assume the worst, that the share price and dividend won’t increase over the next 20 years, a 2.9% dividend yield reinvested and compounded would still turn £1,000 into nearly £1,800 — considerably better than the £1,300 a typical cash ISA would get you.

And if we guess at a very modest 3% share price rise per year with dividend yields consistently at 3%, that £1,000 could become £3,200. In reality, I’d be surprised if we don’t see significantly more than that — and you know, with its long-term strength in mind, I actually don’t think Diageo shares are overpriced at all.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Alan does not own any shares in Diageo.

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