With a price-to-earnings ratio of around 25, shares in global alcoholic beverages company Diageo (LSE: DGE) are not cheap. Sometimes, though, you have to pay a hefty price for quality, and in the long run, ‘quality will out’.
The story of Diageo is not a long one; the company was formed in 1997 with the merger of Guinness and Grand Metropolitan, but some of its its brands go back to the 19th century and in the case of Guinness itself, to 1759.
The Diageo strengths
That it has passed the lesson of history is part of the company’s strength, and it is hard to think of a reason why this should change. If you like to invest in companies or products with long track records, then Diageo has got that track record in spirit – pun intended – even if the company itself is only in its 20s.
Another reason to be positive about Diageo shares is the company’s global reach. The company sells into 180 countries and has been seeing rapid growth in emerging markets thanks to the increasing popularity of its premium brands.
So, that is two boxes ticked: proven track record, global reach. By investing in this one company, you achieve a degree of diversification because its business is not reliant on any one particular region.
Then there is the performance of the share price — up around 18% over the last 12 months, up around 40% over the last five years, and up roughly eight-fold this century.
The downside
The company is a solid dividend payer, but that is also where ‘the case against’ begins. Diageo’s dividend yield last year was just 2%. That’s not terrible, but many companies, even companies operating in the same sector, pay out a lot more. On the other hand, over the next couple of years, the company will also hand out £4.5bn to shareholders, which is around 6% of market cap, through either a share buyback or a special dividend. Investors can’t rely on this payment being repeated in the future, but it is not unlikely.
Another potential risk with Diageo is its exposure to emerging markets at a time when many fear an economic slowdown in these regions. International exposure is a plus, because it protects you against weakness in your home economy, but it also exposes you to changing economic conditions abroad.
Quality will out, eventually
Diageo is not for investors looking for a quick return, but consider this point. If you had bought shares in the company 10 years ago, then today, even without the special dividends/buyback, dividends would be at around 6% of what you paid. That’s what buying quality often means – good long-term returns. Sure emerging markets may be set for a difficult few years, but looking further forward, and they will surely recover.
Diageo is a quality stock for investors with a longer time horizon. It won’t make you rich overnight, but would be a solid addition to a portfolio designed to give longer-term value with limited risk.
