After crashing at the start of the pandemic, the Diageo (LSE: DGE) share price has responded resiliently. In fact, it is currently priced at close to 3,500p, which is an all-time high. This has been driven by a recent strong trading update and a forecast of organic operating profit growth to be at least 14% in 2021. Nonetheless, challenges do still remain, and the Diageo share price may now be overpriced. As such, do I think that there is further to rise, or has it reached its peak?
There is no doubt that Diageo was affected by the pandemic. In fact, mainly due to the closures of bars and restaurants, operating profits in 2020 were £2.1bn, nearly 50% lower than 2019. Despite this, there were a number of positive signs. Firstly, business was able to grow in North America, with operating profits up 4%. There is hope that the company will be able to build on this success in upcoming years. Secondly, despite the lower profits, the drinks giant decided to increase its dividend. This is a major sign of confidence, and the Diageo share price rose as a result.
The most recent trading update has provided more positivity, especially after predicting at least 14% organic growth in 2021. Even so, I was personally more excited by the announcement that it was restarting its return of capital programme. This means that due to its strong performance, Diageo will be returning up to £1bn in share buybacks by the end of the 2022 financial year. This demonstrates that liquidity is strong, and confidence is high.
Despite the company’s resilient performance throughout the pandemic, challenges are still numerous. For instance, coronavirus cases are still very large around the world, and due to the company’s global presence, revenues may continue to be hit in many areas.
Furthermore, Diageo has a debt pile of £15.3bn, giving it a debt-to-equity ratio of around 200%. This is extremely high, and if operating cash flows are negatively affected, it could lead to major ramifications. Although there is no indication that this will happen, it is still a risk to highlight with the Diageo share price.
Finally, I am slightly concerned with the company’s current valuation. For example, it has a forward price-to-earnings ratio of around 25, which is by no means cheap. Evaluating its price-to-book (P/B) ratio also demonstrates the company’s high valuation. Indeed, Diageo has a P/B ratio of 12. Its competitor, Pernod Ricard, on the other hand, has a P/B ratio of just 3.5.
My verdict on the Diageo share price
Due to its ever-growing portfolio of drinks, global presence and strong management, Diageo is one of my favourite FTSE 100 stocks. As such, it makes up a significant part of my portfolio and I feel that it has more scope to rise long term. Despite this, the Diageo share price still looks expensive, and I expect a correction over the next few months. As such, I won’t be buying any more shares right now and may reduce my holding instead. I’m looking elsewhere for bargains.
Stuart Blair owns shares in Diageo. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.