The Diageo (LSE: DGE) share price has plummeted over the last three years and as a result the stock now sports a dividend yield of around 4%. That’s about twice the yield it was offering three years ago (and the highest I can remember from the stock).
I’ve owned Diageo shares for many years now and always viewed it as a core long-term holding. Should I snap up a few more shares in the alcoholic beverages company to pick up this yield?
Facing multiple challenges
When I look at Diageo today, I see a company facing quite a few challenges. Issues include:
- Lower demand for the company’s beverages – right now there are multiple factors leading to lower demand for the company’s products including a global consumer slowdown, GLP-1 weight-loss drugs, and the consumption habits of Gen Z (who are drinking less).
- Donald Trump’s tariffs – these could lead to a $200m hit to operating profits in H2 according to analysts.
- A large debt pile – as of 31 December, net debt-to-earnings before interest, tax, depreciation, and amortisation (EBITDA) was 3.1 times.
- A management team in which investors have lost confidence.
Plenty to like
The thing is, I also see a lot to like here including:
- World class brands such as Johnnie Walker, Tanqueray, and Guinness, many of which are poised to benefit from the ‘premiumisation’ trend (drinking less but focusing on better quality).
- Plenty of exposure to tequila – the fastest-growing spirit worldwide.
- Emerging markets exposure – this could be a major driver of growth over the long run.
- A high return on capital (ROCE) – Diageo remains a very profitable company.
So, it’s not like the company is a complete basket case. In the long run, it still has plenty of potential.
The valuation
As for the valuation, it looks pretty attractive, in my view.
Currently, the consensus earnings per share forecast for the year ending 30 June 2025 is $1.62. That puts the forward-looking price-to-earnings (P/E) ratio at just 16.
That’s a low valuation for a company of Diageo’s quality. That said, there is some uncertainty over near-term earnings due to tariffs, so this P/E ratio may not be accurate.
The dividend
Zooming in on the dividend payout, it looks quite secure to me.
This financial year, dividend coverage (the ratio of earnings per share to dividends per share) is expected to be about 1.6. That’s a solid number.
Meanwhile, this is a company that delivered more than 20 consecutive annual dividend increases. Management isn’t going to want to end that brilliant track record.
My move now
With the stock trading near 2,000p – roughly 50% below its all-time highs – I think it’s worth considering and I’m seriously tempted to buy a few more shares for my portfolio. I’m not 100% decided yet (there are some other stocks I’m looking at) but I may press The Buy button on it in the next few weeks.
I’m not expecting the stock to rebound in the months ahead. But taking a five-year view, I think there’s potential for solid gains, especially when the 4% dividend yield is taken into account.
