At the start of this year, Diageo (LSE:DGE) shares hit the lowest level in over a decade. The share price had been falling for much of the past year (and more), with plenty of problems that the company was trying to shake off. Yet if an investor had perceived three months ago that the stock was becoming undervalued and bought it, what would their return be right now?
Becoming undervalued
Three months back, the stock was trading at 1,706p. It’s now at 1,852p. This reflects an 8.5% increase over the period, meaning that £5,000 invested would be worth £5,425. Of course, this profit is unrealised and would only be banked when selling the stock.
Yet it shows that the worst of the multi-year decline in the Diageo share price is finally coming to a close. Incredibly, the stock’s down 37% over the past two years, with 13% of that coming in the last year. For a FTSE 100 giant, that’s a large loss.
At the core, the issue stems from weaker financials, highlighting slower alcohol demand. This is driven by a few factors, such as consumers cutting spending due to inflation and cost of living pressures. It also points to health trends and lower alcohol consumption by younger people.
Then we have to address the uncertainty caused by US tariffs, particularly with tequila and whisky products. As we saw in the news again this week, President Trump still wants to push ahead with tariffs on global trade partners. Yet despite all of these problems, I can see why the share price has started to stabilise.
Reasons to be optimistic
Effective last month, Diageo has a new CEO, Dave Lewis. He comes in as a turnaround specialist with a strong track record of helping Tesco and is even known as ‘Drastic Dave’ for his cost-cutting exploits. Even though some might see him as extreme, the stock’s reaction shows me that the overall sentiment is positive. He should bring about a cultural and operational overhaul, which I believe is good for Diageo.
Another factor is the valuation. The sharp fall in recent years has exceeded the corresponding drop in earnings per share. What this means is that the price-to-earnings ratio has fallen. It’s now at 14.62, easily below the FTSE 100 average of 18. This could make the stock undervalued. In the coming years, the share price could rebound even if earnings remain unchanged, helping pull the ratio back towards average.
Finally, the performance of core brands remains strong. I’m referring to the likes of Guinness and Johnnie Walker, where Diageo has done well in growing their appeal. If revenue from these names continues to rise, it can provide a strong foundation as we wait for other brands to recover.
Overall, I think the stock can be considered a good value share right now and is one for investors to consider.
