I’ve owned Diageo (LSE: DGE) shares in my ISA for a few years now. And they have been a solid investment for me, providing both capital gains and income. Recently, I decided to buy a few more shares for my portfolio. Here’s why.
Share price fall
Diageo’s share price has come down significantly in recent months. Currently, it is close to its 52-week lows.
One of the reasons is that the company is embroiled in a legal battle with rapper Sean Combs, who says Diageo didn’t treat him fairly when marketing his drinks brands.
Now, this does add some uncertainty here. Combs has said that he’s seeking “billions of dollars” in damages.
However, I see it as a short-term issue.
It’s worth noting that Diageo clearly believes it is in the clear.
“Our steadfast commitment to diversity within our company and the communities we serve is something we take very seriously. We categorically deny the allegations that have been made and will vigorously defend ourselves in the appropriate forum”, said a spokesperson for the company recently.
Attractive valuation
After the recent share price fall, Diageo’s valuation seems very reasonable to me. For the year ending 30 June 2024, analysts expect the company to generate earnings per share of 173p. So at today’s share price, the forward-looking P/E ratio is around 19.
That’s above the average FTSE 100 P/E ratio. But this isn’t an ‘average’ FTSE 100 company.
Ultimately, Diageo has a much better long-term track record in terms of growth, profitability, and dividends than the average Footsie company. So I would expect it to trade at a premium to the market.
It’s worth noting that US rival Brown-Forman, which owns Jack Daniel’s, currently has a P/E ratio of about 29.
So Diageo looks undervalued, on a relative basis.
Growth and defence
I also like the fact the stock offers a nice mix of growth potential and defence.
On the growth side, Diageo still has plenty of room to expand. Over the last decade, ex-CEO Ivan Menezes – who sadly passed away earlier this month – did a great job of building up brands such as Johnnie Walker and Smirnoff in India. Given that India has a population of 1.4bn and disposable income is rising fast, Diageo is well placed for growth here.
Meanwhile, on the defensive side, the company is relatively recession-proof. People tend to drink alcohol no matter what’s happening in the economy. This recession-proof attribute is valuable at the moment, given current levels of economic uncertainty.
Attractive risk/reward
Of course, Diageo shares could fall further from here. Right now, the trend is down.
However, I’d be very surprised if they fell much below 3,000p, as I’d expect this round number level to provide some support.
On the upside though, I think they could easily return to the 4,000p level in the years ahead.
So I see the risk/reward skew as very attractive right now. And with a dividend yield of around 2.6% on offer, I’m getting paid to wait for a recovery in the share price.
