Over the last decade, the Diageo (LSE:DGE) share price has almost doubled. But there’s more than this to Diageo shares as an investment.
The company also pays out a significant amount of its income to shareholders as dividends. So how much would a £1,000 investment made 10 years ago be worth today?
Investment returns
In January 2013, a £1,000 investment in Diageo stock would have bought me 54 shares. Since then, the company has paid out £6.29 per share in dividends to its shareholders.
By reinvesting my dividends along the way, I’d have been able to increase my share count to 69. At today’s prices, that would mean my investment had a market value of £2,533.
That’s a return of £1,533, which amounts to just under 10% per year. I think that’s a really good return and one that I’d be happy with from any of my investments.
As an investor, the question for me is whether or not the stock can continue its impressive performance. A look at the underlying business leads me to think that this is unlikely.
Earnings
The first thing I notice about is that the company’s share price has been growing faster than its earnings. Diageo shares have gone from £18.43 per share in 2013 to £36.71 today.
That’s an average gain of just over 7% per year. By contrast, the company’s earnings per share have increased from 97p to £1.40 — an increase of just 3.75% per year.
That means that a significant part Diageo’s share price gains isn’t due to the underlying business growing. It’s the result of investors being willing to pay higher prices.
I don’t see this as unreasonable investor behaviour. Over the last decade, interest rates in the UK have been low, justifying higher stock prices.
Now, though, interest rates are rising quickly. And I think this will mean that investors aren’t willing to pay such high prices for shares in companies like Diageo.
A stock to buy?
Diageo’s brand profile is absolutely stellar. It includes the top-selling gin (Gordon’s), the top-selling vodka (Smirnoff), and the top-selling Scotch whisky (Johnnie Walker).
I think this means that the company will generate cash for its shareholders consistently for years to come. And that might well be valuable in a recession.
I also agree with Warren Buffett that it’s better to buy a strong company at a decent price than the other way around. But Diageo isn’t a stock that I’m looking at buying right now.
The company’s earnings haven’t kept pace with its share price over the last decade and that’s left the stock somewhat inflated at the moment. That’s why I think there are better opportunities elsewhere.
