Diageo (LSE:DGE) shares tanked this week despite beating analysts’ forecasts in a half-year review. The drinks maker is down around 8% over the week, and the same over 12 months.
The stock is the only British company held by legendary investor Warren Buffett. It’s a small holding, but surely this says a lot about the stock. After all, Buffett has an impressive track record of picking winners.
So let’s take a closer look at this beverage giant, and explore whether an investment in Diageo two years ago would have been successful.
Focus on growth
Diageo is more growth-orientated than most stocks on the FTSE 100. The stock only offers a small 2.2% dividend.
So if I had invested £500 in Diageo two years ago, today I’d have around £580. The stock has surged 16% despite the recent collapse.
Adding in the small dividend payments I would have received over the period, my returns would be fairly strong — close to 20%.
Valuation
Diageo trades with higher multiples than most of the index, and that’s because of its growth potential. The stock has a price-to-earnings ratio of 23.
A discounted cash flow calculation, based on a 10-year investment, suggests the stock is undervalued by around 25%. That’s clearly positive, but it’s worth noting that forecasting future cash flows over the next 10 years can be challenging.
It’s also worth highlighting that while the dividend is small, it’s strongly supported by earnings, with cover of 3.2 times.
Is it worth it?
Is Diageo worth the multiples it trades at? Well, that’s the big question.
Near-term growth has been impressive. In the six moths to the end of 2022, the firm’s operating profit grew 15.2% to £3.2bn. Meanwhile, organic operating profit, excluding acquisitions and currency fluctuations, grew 9.7%. Diageo benefited from both price increases as well as people drinking more premium spirits.
The group now says it’s on track to achieve organic net sales of between 5% and 7%, and sustainable organic profit growth of between 6% and 9%, for 2023 to 2025.
In the long run, the prospects of the company can be linked to the brands which it owns. Johnnie Walker, Guinness, Baileys, and Smirnoff provide defensive qualities, but it’s also worth noting that these product lines also have considerable appeal in developing economies where brands take on more of a status symbol.
Is it for me?
Diageo is a truly international firm, with upwards of a third of its sales ($6bn) in 2021 coming from North America. That’s certainly a positive as risk is spread across the world. Especially now, with a projected downturn in the UK.
Slow economic growth, particularly in the UK, could impact alcohol sales this year. But, once again, brands have defensive qualities, so it’s hard to forecast.
I’ve toyed with buying Diageo shares for some time. But I see this current dip as a good opportunity to buy. As such, I’m looking to add this stock to my portfolio.
