3 Things That Say Diageo plc Is A Buy

DiageoShares in Diageo (LSE: DGE) (NYSE: DEO.US) have dropped by 8% over the past 12 months to 1,815p. But with a dip in earnings per share (EPS) of 5% forecast, we’re still looking at a forward P/E of over 18.

That’s higher than the FTSE average, and Diageo provides a lower-than-average dividend yield, so is it time to sell? I think not, and here’s why:

1. Booze

Come on, it’s booze, and Diageo owns some of the world’s best-known brands — Johnnie Walker, Smirnoff, Gordon’s, Rumple Minze and all the rest. Do you think the world is going on the wagon any time soon?

Demand from China is down a bit after a corruption-inspired crackdown on giving expensive gifts, but you can barely walk into a booze shop anywhere in Asia and not see bottles of Red Label and Black Label on the shelves — and take it from me, it’s very nice with ice and soda on a hot tropical evening.

2. Currency

As well as a dip in Eastern demand, Diageo has been hit by a currency exchange movements this year. With earnings reported in Sterling and the pound rising strongly, the only real surprise to me is that Diageo’s EPS fall is likely to be as low as 5% this year. But that comes from a longer-term trend of rising earnings — we’ve seen double-digit growth in each of the past three years.

The pound will settle to a new level, and we already see a prediction of a 6% recovery in earnings for 2015.

3. Quality valuation

A forward P/E of 18.5 coupled with a dividend yield of 2.8%, when we compare to the FTSE 100 long-term averages of 14 and 3% respectively, do not immediately jump out and shout “Buy me“. But those FTSE averages are for all the companies in the index, including those like ARM, Lloyds and RBS which are paying small or no dividends. It also covers growth shares on very high P/Es, so, erm, ARM again.

Quality companies typically command a higher valuation than average, because of their long-term dependability — and I don’t see them coming much more dependable than Diageo. We have 13 analysts urging us to Buy Diageo against just three on Sell right now, and I have to agree with them.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool recommends ARM Holdings.