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Here’s what I think is next for Diageo’s dividend

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Like many top shares, leading spirits maker Diageo (LSE:DGE) has had a volatile 2020. Earlier in the year, DGE shares fell sharply as concerns over the pandemic’s economic consequences caused sentiment to worsen and the crisis sent its earnings down. 

Lately, however, shares generally have rallied thanks to better than expected vaccine results. Thanks to that rally, DGE shares have clawed back a substantial portion of their declines. 

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So, what’s next for the company’s dividend? Here’s what I think. 

Diageo’s dividend history

In terms of its dividend, the company has previously stated that it aims to increase it each year, although performance and dividend cover always have to be taken into account.

Management has executed admirably on its goal. Diageo has increased its annual total normal dividend every year for more than 20 years. And despite the pandemic, Diageo even increased the recommended dividend for fiscal 2020 to 69.9p per share, up from 68.6p per share in 2019. 

How has it managed this? Importantly, DGE has pricing power and the company can often increase its prices at (or faster than) the rate of inflation given its huge range of leading brands. 

Those price increases, along with increased penetration in emerging markets, have powered a general trend of higher earnings over time, with only occasional exceptions. 

Another reason for the steady dividend increases is that Diageo’s payout ratio isn’t actually that high. DGE pays a dividend yield of around 2.36% at current prices. It aims for dividend cover of between 1.8x and 2.2x and usually achieves at least 1.5x so can often afford to continue to increase its dividend, even in recessions. 

A lot would have to go wrong for earnings to fall to a level that doesn’t cover the dividend and to interrupt the increasing dividend trend. 

What I think is next for the dividend

Given the good vaccine news, I reckon Diageo’s earnings per share can continue to increase in the coming years so the company’s dividend should continue to rise too.

But if I was buying today, I wouldn’t expect fast increases. There will still be a lot of uncertainty in the world in the next few years due to the time it takes to manufacture and distribute vaccines globally. So I believe that DGE management will probably only slightly raise the dividend in both 2021 and 2022. 

Yet once life gets closer to normal in both emerging and developed markets, I think DGE could probably raise its dividend faster each year. And history supports this view. In the immediate years before the pandemic, DGE averaged around a yearly 5% increase in the dividend per share. 

Is the stock a buy for me?

Although it isn’t cheap in terms of its valuation, with a forward P/E ratio of around 26, I’m bullish on Diageo due to its track record. I reckon the company has a wide moat, given its leading brands, and I think management will continue to execute. 

Going forward, Diageo’s emerging and developing market exposure makes the stock an appealing buy to me. 

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Jay Yao has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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