Diageo (LSE: DGE) shares have been a popular defensive choice of late. The price was hit by the pandemic and the effects that had on the hospitality industry. But Diageo has put in one of the strongest FTSE 100 recoveries of the past few years.
Over five years, we’re looking at a 37% gain. That would be good even during positive economic times. Looking back over the past 20 years, we see a massive 450% gain. Add a couple of percent per year in dividends, and I reckon that’s a cracking result by any standards.
By comparison, the FTSE 100 itself has managed less than 120% in 20 years, though with a better average dividend yield.
Dividend
Part of Diageo’s attraction is the dividend. The yield isn’t high, forecast at 2.3%. But it’s been reliable and progressive, and backed by steadily growing earnings.
The current dividend yield comes after Diageo just upped its interim payment. For the first half, the firm reported a 15% rise in earnings per share, excluding exceptionals, to 98.6p. Based on that, it lifted its dividend by 5% to 30.83p per share.
The dividend is strongly supported by earnings, with cover of 3.2 times. Diageo has traditionally been conservative that way, which is one reason institutional investors afford it a high valuation.
Inflation
It also, hopefully, should represent a rise that’s ahead of long-term UK inflation. We’re suffering super high short-term inflation right now. And that makes it hard to evaluate how a dividend strategy might work out when things get back to normal. But Diageo is also extending its share buyback programme, so it appears there’s no shortage of cash.
Diageo reminds me of Unilever in one key way. Unilever owns so many brands, it’s hard to imagine how any family could do their regular shopping without buying any. Mmmm, I fancy a bit of Marmite on toast now.
Diageo is similar in the alcoholic drinks market, owning many brands that might appear to compete with each other. If all Diageo brands were to suddenly disappear, there’d be a lot of empty shelves.
Risk
If Diageo is so good, are there any risks? Well, I see a key one. It’s valuation, which I think could be a bit overheated now. Forecasts suggest a price-to-earnings (P/E) ratio of 21, and it’s a company that operates with a lot of debt funding.
Diageo had net borrowings of £15bn at 31 December 2022. With a market-cap of £79bn, I don’t think that’s too stretching. But it would edge up the P/E valuation further, giving us a multiple of around 25 for the value of the business itself.
Is that too high? Well, the share price has dipped since the results were released, and has been declining since December. Diageo could fall further. But, despite the short-term risk, I think it could be one of the best long-term FTSE 100 investments.
