Is Diageo plc A Super Income Stock?

A Disappointing 2014

It’s been a tough start to 2014 for investors in Diageo. Shares in the alcoholic beverages company have underperformed the FTSE 100 by some distance and are currently down over 11% year-to-date. This is in contrast to the FTSE 100, which is currently down less than 3% for the year. Does a weak share price mean that Diageo has lost its appeal as an income play? Or is it now much better value, making it a super income stock?

Strong Dividend Growth

Although Diageo’s yield of 2.7% hardly makes it stand out as a great income play, it has delivered resilient dividend growth figures over the last few years. Indeed, while the world economy has been struggling to tread water, Diageo has been able to increase dividends per share at an annualised rate of 7% over the last four years. This is highly impressive and is evidence of just how much value the company has received from being focused on building its brands in developing (as well as developed) markets.

diageoFurthermore, Diageo is forecast to increase dividends per share at an above-average rate in future, too. For instance, dividends per share are expected to increase by 7.8% this year and by 8.6% in the following year. This should help to improve Diageo’s yield, although that’s assuming the share price stays where it currently is.

Increasing Payout Ratio

While Diageo is being generous in regard to the pace at which it increases dividends, it could reasonably be argued that it should be doing so at a faster rate. For instance, Diageo paid out around 45% of earnings as a dividend last year and, for a mature company that operates in a mature industry, this proportion could be far higher. So, in addition to the aforementioned dividend per share growth forecasts being strong, Diageo could surprise on the upside with regard to dividends as a result of adopting a more generous dividend payout ratio.

Looking Ahead

As mentioned, shares have had a tough time in 2014 and have underperformed the index. Despite this, Diageo’s price to earnings (P/E) ratio remains relatively high at 17.1. This makes shares considerably more expensive than the FTSE 100, which has a P/E of 13.5. However, strong dividend growth prospects, a resilient outlook on the stability of dividend payments and the scope to pay a greater proportion of earnings as a dividend mean that Diageo is still a super income stock.

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Peter does not own shares in Diageo.