Long-term buy-and-hold investing is the best way for most stock market investors to build wealth. However, it’s becoming increasingly difficult to find companies that will even survive the long term, let alone generate steady returns for investors.
Indeed, a study conducted by Professor Richard Foster of Yale University during 2015 showed that the average lifespan of a company in the global S&P 500 index has fallen from 61 years in 1959 to just 18 years. This implies that by 2027 more than three-quarters of the companies listed in the S&P 500 will be those that we’ve not yet heard of. Even more shocking is the statistic that the average lifespan of an ad tech company is just six years.
Many factors are contributing to shorter company life expectancies including technology changes, disruption, regulatory changes and general attrition. All of these factors are making life harder for the long-term buy-and-hold investor.
Nonetheless, there are still some companies that have all hallmarks of a long-term winner and drinks giant Diageo (LSE: DGE) is one such.
It’s all in the brand
When Warren Buffett first bought Coca-Cola in the late 1980s, he recognised the company had a great brand with a worldwide following, and this was worth more to the business than anything else.
Diageo owns not just one great brand, but many great brands in the drinks industry and these brands come with a heritage that’s impossible for any competitor to replicate. Brands such as Guinness and Johnnie Walker whisky have been around for centuries and have appealed to many different generations, which means customers are fiercely loyal to these brands.
As a result, Diageo is almost immune to competition and disruption. Granted, the company’s sales growth has slowed in recent years as competition in the drinks sector increases and the group deals with slowing demand for its spirits within China, but Diageo now seems to be back on track. The first half of 2016 saw net sales growth of 2.8% and operating profit growth of 1.6%.
Cash cow
Diageo’s product portfolio isn’t its only strength. The business also has fat profit margins and generates billions of pounds in free cash flow every year.
For 2016 the group generated free cash flow of £2.1bn on an operating margin of 27.1%. With such a healthy inflow of cash for the year the company was able to pay down £1bn worth of debt and return £1.5bn to shareholders.
Aside from Diageo’s brand portfolio, the company’s operating margins and free cash flow, one of the most impressive metrics about the business is its return on average invested capital (ROIC). This measures how much profit a business can generate for every pound invested. According to consultancy McKinsey, the average ROIC for blue chips for the past five decades is in the region of 10%. Diageo’s ROIC last year was 12.1%, which clearly shows how strong the company’s business model is.
All in all then, Diageo’s world-class brand portfolio, impressive free cash flow and above-average returns on capital show that the company is one business you can rely on to be around for a long while yet.
