Premium alcoholic drinks maker Diageo (LSE: DGE) is the stock I’d choose if I could have only one.
It’s a useful exercise to pretend we can only have one. And it forces a considered approach to research.
And for me, the number-one consideration is the sleep-at-night factor. The last thing I’d want is to fret about my holding and wonder whether the underlying business is performing well or poorly.
But with Diageo, the sleep-at-night dial is set high. And the business has a fine record of consistent performance. So I’d have reasonable confidence the company will go on to trade well into the future.
A couple of important things are stacked in its favour that drive the consistency in trading. The first is that it operates in the fast-moving consumer goods (FMCG) sector. And its business model involves suppling consumable goods that customers use up then return to buy more, over and over again.
And any setup like that has the potential to generate predictable and consistent cash flow. But Diageo boosts those performance characteristics with the strength and power of its brands. I’m talking about names such as Guinness, Smirnoff, Johnnie Walker, Captain Morgan and others.
Strong brands create an advantage for Diageo and competitors will likely find it hard to challenge the company for market share. However, the cost-of-living crisis might be driving some previously loyal customers to cheaper alternatives. And that could be one reason the share price has been weak lately.
But the second thing that helps to maintain the consistency of Diageo’s trading figures is the nature of the product. Alcohol consumption can be addictive. And that factor tends to make the repeat-business side of the equation even stronger.
However, for some investors, taking advantage by buying Diageo shares will be distasteful. And some people put the company in a pile with others like cigarette makers Imperial Brands and British American Tobacco. Such businesses are sometimes labellled as ‘sin’ stocks.
The risk of de-rating
The trend towards ethical investing may be another reason for the recent weakness in Diageo’s share price. However, another unfortunate circumstance is the recent passing of long-time chief executive Sir Ivan Menezes. And that sad event may be affecting the stock because Menezes led the organisation with great success for many years.
One of the risks with Diageo now is the possibility of the valuation de-rating continuing. The stock was historically always expensive in valuation terms. And that’s because investors know well the attractive financial qualities of the business.
Indeed, the multi-year dividend record shows compound annual growth running at just above 4%. And revenue, earnings and cash flow have all been rising steadily as well.
With the share price near 3,369p the dividend yield is around 2.5%. And although that’s not the highest around, I’d be inclined to embrace the risks and research the company now. My aim would be to add the stock to a long-term diversified portfolio focused on building or maintaining a retirement fund.