Why Is Diageo plc So Expensive?

DiageoLooking around the FTSE 100, we find a lot of companies trading on P/E valuations not too far from the index’s long-term average of 14. That’s not surprising — these are mainly mature blue-chip companies with their rapid growth years behind them, and with not much in the way of risk facing them.

But some are valued significantly higher.

Take Diageo (LSE: DGE) (NYSE: DEO.US) for example. It sells booze, which is a pretty staple commodity, yet its shares are on a high P/E — they ended the year to June 2013 on a multiple of 18, and forecasts for the current year suggest 19.5.

Why so high?

Higher-than-average dividends can cause an uprating, but there’s a yield of only 2.7% expected from Diageo this year — with the FTSE averaging a little over 3%. So that’s not the reason

But, of course, if two companies are raking in the same earnings per share and shelling out the same dividends, investors will be more keep to own the one they see as more reliable — and that will mean a higher share price in relation to those earnings.

Diageo is one of those companies. Sure, it only sells booze, but that tends to do well whatever the economic conditions — in down times people are drowning their sorrows, and in happier days they’re celebrating!

And alcohol is just not going to go out of fashion any time soon. Brand-appeal will change, of course, but Diageo has that covered, with Johnnie Walker, Gordon’s, Hennessey, Moët & Chandon, Bailey’s, Smirnoff, Bushmills, Pimm’s and, of course, Rumple Minze all in its stable.

How is Diageo doing itself?

In the nine-month period to March 2014, organic sales were a modest 0.3% ahead of the same period last year — and that was down from 0.9% growth at the halfway stage three months earlier.

The damage was done in the Asia Pacific region, which saw a 19% decline in sales for the third quarter to take the nine-month figure down 9.4%. Political instability in Thailand leading to last month’s military coup had a serious impact, as did a drop in sales in China — China’s credit and property markets are looking a little fragile at the moment, and that may well have hurt consumer confidence. North America sales were up 3.7%, with Europe pretty much flat on a 0.4% slip.

But that’s the worldwide mix that makes Diageo relatively stable overall, and makes a lot of people want to buy the shares.

A bargain now?

Still, a note of caution must be sounded, as it’s only since late 2008 that the Diageo share price has been outstripping the FTSE 100 — prior to that, it was pretty much neck-and-neck with the index. Further outperformance would send that P/E even further ahead of the average, and I can’t see that happening over the next few years.

For my money, at 1,920p Diageo shares are high enough.

Diageo is one of the companies given the nod in "The Fool's Five Shares To Retire On" report, which tells you a bit more about the company's global reach and it's long-term potential. If you're looking to form the foundation of a long-term portfolio, the report could be a great help to you.

It's completely free, and you might like the ideas -- so just click here to get your copy today!

Alan does not own any shares in Diageo.