The shares of FTSE 100 drinks giant Diageo (LSE: DGE) (NYSE: DEO.US), currently trading at 1,827p, have soared 121% over the last five years, more than double the 57% gain for the index.
However, the story could change over the next five years, as Diageo’s shares have the potential to advance by a less bubbly 31%.
Here’s how
Diageo, the world’s leading premium drinks business, has an outstanding collection of brands, including Johnnie Walker whisky, Baileys liqueur and Guinness stout. Manufacturing across the globe, and trading in 180 countries, the company is particularly well-positioned to benefit from rising prosperity in emerging markets.
In the very near term, though, earnings are expected to dip, impacted by adverse currency movements, and a number of local factors, including a government clamp-down on extravagant gift-giving in China and political unrest in Thailand. City analysts are expecting a 5% decline in earnings per share (EPS) for the company’s current financial year (ending 30 June), but growth to resume thereafter.
Nevertheless, the earnings blip puts a crimp in the analysts’ five-year forecasts. The consensus is for EPS to increase at a compound annual growth rate (CAGR) of 7.4% from last year’s 104.4p to 149.3p by the year ending June 2018 — a total increase of 43%.
If the shares track earnings, and continue to rate on their current historic price-to-earnings (P/E) ratio of 17.5, the price will of course rise by the same 43% as EPS, putting Diageo’s shares at 2,613p five years from now.
However, the FTSE 100’s long-term average historic P/E is 16, so if the market happened to de-rate Diageo from its premium P/E to the Footsie average, we’d see the shares at 2,389p — a rather modest 31% rise from today’s 1,827p, compared with the 121% gain seen over the last five years.
Arguably, though, Diageo merits a premium P/E, because its business is ‘defensive’ — that’s to say, alcohol consumption tends to be relatively resilient, even in recessionary times. As such, it would be no surprise to see the current 17.5 P/E maintained and the stock deliver the more respectable five-year gain of 43%.
Investors shouldn’t expect chunky dividends on top, though, because today’s starting historic yield is just 2.6%, and analysts are forecasting a dividend CAGR of 7.5%, about in line with earnings. We’d see a total of 299p a share paid out over the period. Put another way, a £1,000 investment in Diageo today would deliver £164 in dividends — about half the income forecast to be paid by banking giant HSBC.
There’s no guarantee that Diageo’s earnings and dividends will play out as the analysts are forecasting. History tells us, though, that quality businesses, with fantastic brands, are capable of delivering for shareholders year after year, decade after decade.
