The Diageo (LSE: DGE) share price has surged over the past 12 months. The stock has increased in value by a 22.4%, excluding dividends over this difficult period, compared to a return of 13% for the FTSE 100.
Following this rally, shares in the drinks giant are trading close to their all-time high. And not only is the stock near that all-time high, but the firm’s valuation has also surged. At the time of writing, the stock is selling at a forward price-to-earnings (P/E) multiple of 31.7. The five-year average multiple is 22.
After this performance, investors could argue that the Diageo share price is overvalued. However, I think there is still time to buy the stock.
Diageo share price outlook
To explain why I think the stock is not yet overvalued, I should explain what Diageo owns. The company owns and manufactures some of the most respected alcohol brands in the world. Brands such as Smirnoff vodka and Johnnie Walker whisky.
These brands are worth billions of pounds, and it would be incredibly challenging for an upstart competitor to recreate their brand value and international distribution network (although not impossible).
The strength of these brands gives the company an edge as it can virtually charge what it likes for the products. In an inflationary environment, such as the one we see today, this kind of pricing power is invaluable.
Further, the company is investing in new brands, buying up smaller firms to expand its offering, and has a long runway for growth ahead of it. Despite being one of the world’s largest alcoholic beverage producers, Diageo still makes up less than 5% of the global market.
These numbers suggest that while the Diageo share price might seem overvalued today, if the group can execute a successful growth strategy over the next decade or so, it can grow into the valuation.
Far from guaranteed
Unfortunately, the group’s growth is far from guaranteed. Past performance should never be used as a guide to future potential. Just because the company has grown to become an industry giant over many years does not mean it will retain this position.
Alcohol is regulated as a drug in many markets worldwide, and Diageo has to deal with increasingly strict regulations in many of its markets. These regulations and restrictions could hold back growth.
Still, I think the potential rewards that the Diageo share price could offer far outweigh these risks. That is why I would buy more of the stock for my portfolio today. Just like every other firm, the group will face challenges as we advance. Nevertheless, I am confident it can overcome these issues. As it executes its growth strategy, the stock may only become more attractive as an investment, I feel.
