Diageo (LSE: DGE) is a leading spirits and beer maker with a portfolio of well-known brands such as Smirnoff and Captain Morgan.
Earlier in the year, Diageo shares fell due to the pandemic. Because of Covid-19-related lockdowns, people haven’t visited restaurants and bars as often and that’s hurt alcohol consumption.
Lately, however, shares have risen as optimism over Covid-19 vaccine candidates has increased.
Tasty dividend
One reason why many investors like Diageo is its dividend.
Thanks to great management execution and the company’s competitive advantages, Diageo has increased its annual total normal dividend every year for over two decades. Including this year’s dividend raise, the company now has a dividend yield of around 2.38% at current prices.
Given the vaccine candidate optimism, I think the odds that Diageo will increase its dividend next year are also pretty high. While Diageo has a great dividend history, I think there’s a lot more to like about the company than the dividend.
Here are two more reasons why I’d buy the stock:
Leading brands
I like Diageo because the company has many leading brands. In this sector, brands can be pretty profitable when done correctly.
One of Elon Musk’s side ventures is a great example of the profit potential of branding in the industry. Recently, Musk’s Tesla sold out of its very own liquor, Tesla Tequila. Enclosed in a very stylish looking bottle, Tesla Tequila cost $250. This was a steep price when a comparable bottle from another company could be bought for a fraction of that. To me, the ‘mark up’ illustrates the power of Musk and Tesla’s brand.
To me, this also illustrates that the returns on capital in the liquor industry can be pretty decent given the right execution.
In terms of the returns on capital, Diageo does pretty well in my opinion. According to Fidelity, Diageo had a return on equity of 34.52% and a return on invested capital of 16.39% for 2019. In 2012, the company had a return on equity of 35.30% and return on invested capital of 15.58%.
For many investors, a stock with consistently high returns on capital can potentially illustrate a company with competitive advantages. Given great management and enough positive long-term trends, the stock could be a great holding.
Emerging and developing markets
Speaking of positive long-term trends, I like Diageo because the company has exposure to a number of emerging and developing markets. For the year ended 30 June 2020, for example, 19.3% of the company’s sales came from its Asia Pacific region. Another 11.5% came from Africa and 7.8% from Latin America and the Caribbean.
With up and coming trends such as AI and 5G, I think productivity in emerging and developing markets could potentially rise faster than expected. With more productivity, incomes could rise. As the middle class grows, demand for the type of premium beer and liquor Diageo sells could outperform.
Although Diageo doesn’t trade for a cheap valuation, I think the company’s growth potential outside the West makes the stock worth owning in the long run. It’s a stock I’d buy and hold for the long term.
