Growth Potential Makes Me Bullish On Diageo plc

Diageo (LSE: DGE) (NYSE: DEO.US) has seen its share price fall recently as a result of question marks surrounding the growth story of the developing world.

Indeed, it has led to earnings per share (EPS) forecasts being revised downwards, with EPS for the year to the end of June 2014 expected to have grown by 7% rather than the 9% that was forecast just a month or two ago.

However, 7% is still a punchy growth rate for earnings when you consider that the British economy is struggling to generate growth of one-third of that.

So, while I appreciate that further revisions to EPS forecasts following Diageo’s first-quarter update may make investors wary, I’m still bullish on its long-term prospects. Furthermore, I believe that mid to high single digit percentage growth over the next year is adequate and that it leaves the company in a strong position to deliver encouraging medium- to long-term growth.

In addition to the relatively high growth rate, I remain attracted to the generous level of returns that the company is able to offer to investors.

For instance, return on equity last year was a superb 32%. However, what really impresses me about Diageo’s return on equity is the fact that it has always been above 30% over the last 5 years and has averaged 35% over the same period.

This not only shows that Diageo is highly profitable, but that earnings are relatively stable and consistent. I believe this bodes well for future years and that short term issues should not cause major problems in the long run.

Meanwhile, I’m in favour of the large reinvestment being made in the business. For instance, Diageo’s capital expenditure was £643m last year, with it investing in new distilleries, as well as various pieces of equipment that should reduce future costs and help to streamline the production process. Such spending should be to the benefit of long-term shareholders.

So, I’m bullish on Diageo’s prospects because of the attractive earnings growth rate, the high and consistent returns to equityholders as well as the large amount of reinvestment in the business. Moreover, short-term revisions to growth forecasts do not put me off: I think the long-term growth story remains intact.

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> Peter does not own shares in Diageo.