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Why I’d Buy Diageo plc Over SABMiller plc After Director Buying

Diageo’s (LSE: DGE) (NYSE: DEO.US) CEO, Ivan Menezes, recently purchased an additional £650,000 of shares in the company and, according to some investors, this could be seen as a positive sign in terms of him having faith in the future of the business.

Clearly, only time will tell but, even if Diageo’s CEO hadn’t bought any more shares in the company, it still appears to be a great stock to own at the present time. Sure, the last year has been challenging and its share price has fallen but, looking ahead, it could be a better buy than sector peer, SABMiller (LSE: SAB) (NASDAQOTH: SBMRY.US). Here’s why.

Valuation

On the face of it, Diageo does not appear to offer good value for money. For instance, it has a price to earnings (P/E) ratio of 19.6 and, with the FTSE 100’s P/E ratio being 15.9, it seems to be overvalued on an absolute and relative basis.

However, when you compare it to its nearest peer, SABMiller, it seems to make much more sense as an investment. For example, SABMiller trades on a P/E ratio of 22.7 and this is a full 16% higher than Diageo’s rating, which indicates that there is considerable scope for a narrowing of this valuation gap moving forward.

Higher Returns

Despite this difference, Diageo is the company that offers investors the best returns and is the most profitable. For example, last year it had a return on equity of 29%, which is hugely impressive, while SABMiller’s was less than half that at 13%. Clearly, that’s still a great return, but Diageo appears to have the greater potential to increase its bottom line moving forward, with its relentless focus on diversification arguably allowing it to be more nimble than SABMiller to changes in local tastes.

For instance, the emergence of craft beer has left SABMiller and other major brewers somewhat wrong-footed and, even though they are now adapting to the more varied demands of consumers, it is more difficult for a company that relies on a number of brands within one space (i.e. SABMiller with beer) to remain as relevant than it is for a company with multiple brands in multiple spaces (i.e. Diageo with its major vodka, whisky and tequila brands). This should mean that Diageo maintains its edge regarding returns to equity holders over the medium to long term.

Looking Ahead

Although both companies do have considerable future potential and may prove to be excellent investments, Diageo seems to have the edge. Not only is it substantially cheaper, it is also more nimble and is generating significantly higher returns for its shareholders. As such, the disappointing year that Diageo has endured may prove to be a good opportunity to buy a slice of the company; just as its CEO did last week.

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Peter Stephens has no position in any shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.