Should I buy Diageo shares or not touch them with a bargepole?

Here’s what I think is the reason for Diageo shares falling and what I’m doing about it for my portfolio as the valuation improves.

| More on:
Middle-aged black male working at home desk

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

What’s going on with Diageo (LSE DGE) shares right now?

We’re in a bull market and stocks have been going up. But the premium alcoholic drinks supplier is trending down, and it has been since the end of 2021.

That’s not ‘supposed’ to happen to a quality business. And the company is certainly that. It scores well against the traditional quality indicators.

Quality at a price to match?

For example, the operating margin is almost 27%. That compares to an arguably lower-quality business, such as Tesco, at just over 4%.

Diageo’s return on capital is about 15%. Meanwhile, Tesco can only manage a little over 8%.

Nevertheless, even Tesco has participated in this bull run:

One of the problems is Diageo has had a rich-looking valuation for years.

Remember all the hype about so-called bond-proxy trades?

When interest rates were on the floor for years following the credit-crunch and great recession of the noughties, investors earnt little on their cash deposits. instead, they turned to companies with defensive operations and labelled them bond-proxies.

Because operations were considered resistant to the ups and downs of the wider economy, the defensives were almost as reliable as putting money into a bond, went the argument.

Was it all just another bubble?

Investors were all over these types of shares. Why? Because they believed the underlying businesses could offer predictable returns and sometimes have higher yields than bond market offerings.

Other stocks caught up in the craze included fast-moving consumer goods outfit Unilever, smoking products supplier British American Tobacco and others.

The outcome over about a decade from around 2009 was a massive bull market for these defensive, bond-proxy stocks — and valuation expansion. So, price-to-earnings ratios increased as the share prices rose.

Most good things end though. Now it looks like those stocks were in another bubble. In hindsight, they look as if they had become overvalued compared to their rates of earnings growth.

Because of that, it looks like Investors have likely been selling the shares. Events conspired to push the valuations lower as well. For example, interest rates have been improving, making actual bonds and cash accounts more appealing. So, there’s less need to invest in defensives as a bond-proxy anymore.

On top of that, the pandemic crash caused cyclical stocks to look better value, so some investors likely rotated out of the defensives and into them.

That scenario repeated itself at the beginning of the bull run starting last Autumn in 2023.

There’s also been war, supply-chain problems, inflation and other things. The common theme is that all those events put pressure on overvalued stocks like Diageo and the other one-time bond-proxy darlings. And that’s on top of any company/business-specific issues they may have endured.

What I’d do now

Nevertheless, Diageo is still a great company and may make a decent long-term investment – at some point.

So, should I buy or go nowhere near?

Well, I’d never buy while a downtrend remains in place, despite an improving valuation.

So, for now, I’d dig in with deeper research and watch Diageo while keeping a safe distance from the shares. But that position may change quickly!

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco P.l.c., Diageo Plc, Tesco Plc, and Unilever Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Businessman use electronic pen writing rising colorful graph from 2023 to 2024 year of business planning and stock investment growth concept.
Investing Articles

Buying 8,617 Legal & General shares would give me a stunning income of £1,840 a year

Legal & General shares offer one of the highest dividend yields on the entire FTSE 100. Harvey Jones wants to…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

£25k to invest? Here’s how I’d try to turn that into a second income of £12,578 a year!

If Harvey Jones had a lump sum to invest today he'd go flat out buying top FTSE 100 second income…

Read more »

Union Jack flag in a castle shaped sandcastle on a beautiful beach in brilliant sunshine
Investing Articles

2 lesser-known dividend stocks to consider this summer

Summer is here and global markets could be heading for a period of subdued trading. But our writer thinks there…

Read more »

pensive bearded business man sitting on chair looking out of the window
Investing Articles

Here’s how I’d aim to build a £50K SIPP into a £250K retirement fund

Our writer outlines the approach he would take to try and increase the value of his SIPP multiple times in…

Read more »

Investing Articles

9.4%+ yields! 3 proven FTSE 100 dividend payers I’d buy for my Stocks and Shares ISA

Our writer highlights a trio of FTSE 100 shares with yields close to 10%. He'd happily pop them into his…

Read more »

Mixed-race female couple enjoying themselves on a walk
Investing Articles

Are Raspberry Pi shares a once-in-a-lifetime chance to get rich?

With Raspberry Pi shares surging after a successful IPO, could this UK tech startup offer a long-term wealth creation opportunity…

Read more »

Newspaper and direction sign with investment options
Investing Articles

Huge gains and 9% yields: why now’s an amazing time to be a stock market investor

The stock market’s generating fantastic returns in 2024. Whether you're looking for gains or income, it’s a great time to…

Read more »

Hand of person putting wood cube block with word VALUE on wooden table
Investing Articles

This steady dividend payer looks like one of the best bargain stocks in the FTSE 100

A yield of 4.7% and a consistent dividend record make this FTSE 100 company look like good value in an…

Read more »