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You Could Enjoy 10% Annual Returns Over The Next 20 Years With Diageo plc

Rejoice, Foolish readers.
 
ECB chief Mario Draghi has hinted he could launch a QE programme to help the shaky eurozone…
 
The S&P 500 has closed above 2,000 for the very first time…
 
Warren Buffett has laid out $3bn to help finance Burger King’s $11bn purchase of Canada’s Tim Horton’s
 
Yes, the summer sell-off looks to be over as the good news rolls in and the FTSE 100 teases us again as it hovers just above 6,800 – a whisker away from the magic 7,000 and a new all-time high.
 
Seems to me as if some people have not waited for St Leger’s Day to get back into this market.
 
(It’s a week on Saturday, if you’re still sitting on the sidelines.)
 
All the excitement prompted Patrick Spencer of brokers Robert W Baird & Co to summarise the other day on Bloomberg:
 
Geopolitical events are significant and major new attacks are tragic, but they’re not enough to unsettle the global economic forces in play… Draghi gave clear indications that he’s standing ready with further measures to stimulate growth and that’s helping overall sentiment.
 
Indeed, within Investment Week, fund manager Richard Buxton reckons investors could have a “clear run” between now and next year’s general election:
 
Traditionally, the Bank of England tries not to move rates in the six month run-up to an election. If Carney does not move rates by November, it is unlikely they will move until next May
 
Some even claim BoE governor Mark Carney has agreed a pact with George Osborne not to raise the base rate before the election…
 
And if that’s the case, then rock-bottom savings rates could be here for some time to come. Position your investments accordingly.

The uncomfortable truth for anyone holding cash for the long term

Certainly a fair few of us investors have already positioned our investments accordingly.
 
Indeed, stats from the Investment Management Association show more than £1 BILLION was poured into UK equity income funds during June by ordinary investors…
 
And that was followed by more than £1 BILLION going the same way during July.
 
To put the billions into context, 60p of every £1 invested in any type of managed fund – equity, property, bond, mixed, overseas, money market or hedge – over the summer found its way into UK equity income portfolios.
 
I can’t say I’m surprised.
 
I mean, what with the average Cash ISA rate at around 1.5% according to Moneyfacts, shares are the only game in town.
 
Take GlaxoSmithKline as a textbook example. I mentioned it the other day as yielding 5.7% at £14.
 
Other blue chips with high yields and steady reputations include Admiral at 7.5%, SSE at 5.9%, J Sainsbury at 5.6%, Centrica at 5.5% and Vodafone at 5.4%.
 
Heck, even a boring old index tracker pays a 3% income with the prospect of a rising payout and capital gains.

After tax, the uncomfortable truth for anyone holding cash for the long term is that deposit accounts are being left miles behind by company dividends and are simply not keeping pace with inflation. From a spending-power perspective, you are effectively losing money

The group’s super track record and dependable operations could make it a winner for Foolish long-haul investors

One person backing shares and dividends over cash in the bank is Nick Train.
 
Now, regular Collective readers may remember I’ve mentioned Mr Train before.
 
Yep, he’s the guy that runs the Finsbury Growth and Income investment trust who claimed last year that “the background conditions are as encouraging for equity investing as at any time since, say 1801, when the London Stock Exchange was founded.
 
Now Mr Train may sound like a bull-market crackpot with quotes such as that. But his Finsbury trust has trounced the wider market since he took charge in 2001, suggesting he knows what he is talking about.  

collectiveSep1

Source: Capital IQ

Anyway, Mr Train likes his reliable dividend payers and has Diageo (LSE: DGE) (NYSE: DEO.US) among his top selections.
 
True, Diageo has never really been the highest yielding share. Even with the recent price below £18 – compared to an all-time high of £21 set last year – the stock yields just 2.9%.
 
Yet Mr Train reckons the group’s super track record and dependable operations could make it a winner for Foolish long-haul investors.
 
You see, writing for Hargreaves Lansdown the other week, he recalled Diageo’s payout and share price had both quadrupled during the last 20 years.
 
That works out at an annual compound growth rate in both of just over 7%.” calculated Mr Train.
 
Now 7% a year share price gains may not sound so thrilling, but reflect on the fact that the FTSE All Share Index itself has only managed just over 4% p.a. capital gains over the period and that is the difference between an increase of 2.3x for the index and that 4-fold gain for Diageo. With dividends added on top Diageo has chunked out average annual returns of over 10% for twenty years.
 
10% over 20 years? I would certainly take that. I’m sure you would, too.
 
That might not be your very best investment over the period, but who wouldn’t want that sort of market-beating return at the core of their equity portfolio?
 
According to Mr Train, it may not be too late to put Diageo at the core of YOUR equity portfolio… and enjoy 10% annual returns during the next 20 years.
 
Indeed, the chances of the dividend quadrupling again (to 207p) and the share price quadrupling again (to £72) during the next 20 years, he says, are “pretty good”.

Indeed, we’ll be disappointed if it takes that long.

And if you consider:

  • the group’s wide range of popular and venerable brands, such as Johnnie Walker and Baileys;
  • the fact the business enjoys amazing 30% profit margins, and;
  • the growing opportunities to sell more drinks within emerging markets…

…then perhaps the next quadrupling of Diageo’s share price and dividend may take somewhat less than another 20 years.

Either way, I believe that Diageo’s shares will smash the returns from Cash ISAs over time. Certainly it’s the type of enduring stock where you shouldn’t need to worry too much about central bankers, summer lulls and the timing of St Leger’s Day to enjoy potentially outstanding returns.

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Maynard does not own any share mentioned in this article. The Motley Fool has recommended shares in GlaxoSmithKline.