There are many passive income opportunities available to investors in the FTSE 100. This blue-chip index is literally teeming with stocks that pay generous dividends.
In my own portfolio, I already hold shares like Legal & General, Aviva, HSBC, and Londonmetric Property for dividends. But one I don’t currently own is Diageo (LSE:DGE), the drinks giant behind timeless brands like Guinness, Johnnie Walker, and Tanqueray.
I’m on the lookout for a dividend stock to buy in May. Should I add the Guinness maker to my Stocks and Shares ISA?
A permanent industry
When I look at Diageo, there are a number of things that immediately appeal to me. The most obvious is the exceptional portfolio of brands, as mentioned above.
I expect most of these drinks to still be selling at a profit worldwide long after I’m gone. After all, Guinness and Gordon’s Gin have been around since the 1700s, and Johnnie Walker, Smirnoff, and Tanqueray since the 1800s.
The best quality to look for in dividend-paying businesses is arguably longevity. That is, products, brands, and services that people will still be paying for in 50 years’ time.
Alcohol might be in decline in some places in the world due to health and fitness trends, but it’s been around since our primate ancestors first metabolised ethanol (the alcohol in rotting fruit) about 10m years ago. Beer itself is many thousands of years old.
Diageo has been paying dividends for 30 years. Even during the pandemic, when many firms suspended their payouts due to lockdowns, the spirits firm continued distributing dividends. That’s because people were still buying its brands to drink at home.
Last year, Diageo generated free cash flow of $2.75bn from net sales of $20.3bn. So this is a very established business that generates a lot of cash (crucial for dividends).
A troubled stock
Unfortunately, one look at the Diageo share price tells us that all is not well. It’s down 55% in the past five years!
The company has been hit hard by squeezed consumer spending, which has resulted in fewer people going to bars, clubs, restaurants, and so on. Meanwhile, some drinkers have been trading down from Diageo’s premium offerings, particularly in tequila in the US recently.
As such, Diageo has been struggling to grow sales. For the current fiscal year, which ends in June, management expects organic net sales to fall between 2% and 3%.
Worryingly, from an income perspective, the interim dividend was cut in half in February. The company did this to reduce leverage and increase financial flexibility, with an eye on the balance sheet, which has become a bit of a worry.
Looking at this then, I don’t think Diageo will be producing snowballing passive income moving forward.
My move
That said, the firm has still committed to “growing shareholder distributions over time and targeting a 30-50% payout policy going forward“. The forward dividend yield is still decent at 3.4%.
Moreover, the value looks cheap, with the stock trading at just 12 times forward earnings. And new CEO Dave Lewis, who helped turn around Tesco a decade ago, is busy formulating a turnaround for Diageo.
So, with its cheap valuation, 3.4% yield, and recovery potential, Diageo is tempting me to invest.
