Three Ratios That Make Me Want To Buy Diageo plc Today

Roland Head takes a closer look at the Diageo plc (LON:DGE) business and finds that the numbers suggest the drinks firm is a clear buy.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

I’ve always admired the quality of the Diageo (LSE: DGE) (NYSE: DEO.US) business, but I haven’t ever been persuaded to invest in the firm, due to its high P/E ratio and below-average yield.

However, Diageo’s share price is down by almost 10% from its August peak of 2,152p, while its business continues to prosper. This combination has made me reconsider my decision not to invest, and take a closer look at this first-class booze maker.

Not so expensive

The first thing I noticed was that Diageo’s falling share price and strong earnings growth mean that its 2013/14 forecast P/E ratio has fallen to around 16.9. At the same time, Diageo’s prospective yield has risen to almost 2.8%.

That’s still pricey, but it’s not outrageous, given the FTSE 100 averages of 13.6 and 3.2%. Diageo’s track record of outperforming the FTSE 100 — it has a ten-year average trailing return of 13.5%, versus 7.9% for the FTSE, according to Morningstar — means that it is reasonable to expect to pay a moderate premium for the company’s shares.

High profits

Diageo’s portfolio of leading premium brands — such as Guinness, Johnnie Walker and Smirnoff — means that customers are willing to pay a little more for their favourite drink.

This translates into remarkably strong profit margins for Diageo, which has an operating margin of around 22%. Of course, paper profits are no good if they don’t translate to free cash flow, but Diageo scores well here, too: it generated free cash flow of £1.5bn last year, representing 44% of its operating profits.

Shareholder returns

Diageo’s underlying book value — the net ‘sell-off value’ of the business — has doubled from £3.5bn to £7.0bn since 2008, rising much faster than its net debt, which is only 32% higher than it was at that time.

The significance of this is that it shows how Diageo’s management has created genuine growth for shareholders, rather than simply pumping up the company using debt.

Diageo’s return on capital employed — a key measure of growth in invested capital — has remained steady at between 16 and 20% for at least the last six years, during which time the firm’s gearing has fallen from 188% to 118%.

Although gearing of 118% is still higher than I like to see, given Diageo’s track record of asset and earnings growth, I think it’s acceptable — making Diageo a tempting buy.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Roland does not own shares in any of the companies mentioned in this article.

More on Investing Articles

Young female business analyst looking at a graph chart while working from home
Investing Articles

After collapsing 28% today, are Bunzl shares too cheap to ignore?

A poor trading statement has sent Bunzl shares to multi-year lows. Could now be a good time to consider investing…

Read more »

Investing Articles

These 5 stocks could earn £1,600 of annual passive income in a £20,000 ISA

Harvey Jones shows how to generate a high and rising passive income by buying a balanced mix of high-yielding FTSE…

Read more »

Young woman holding up three fingers
Investing Articles

3 things I like about Greggs shares

Greggs shares have tumbled by more than a third over the past year. But this writer has no plan to…

Read more »

artificial intelligence investing algorithms
Investing Articles

Nvidia stock: beware the bear market rally

Andrew Mackie argues that investors should tread carefully before investing in Nvidia stock, as the worst of the sell-off could…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

Up 73% in one year, is this the best value stock in the FTSE 100?

A brilliant run of form suggests this FTSE 100 giant should no longer make the cut as a value stock.…

Read more »

Investing Articles

The best could yet be to come for UK shares! I’m buying these ones

Amid ongoing stock market turbulence, this writer's been adding selected UK shares to his portfolio. Here's why and what he…

Read more »

Top Stocks

4 UK stocks trading well below book value to consider buying

Sometimes, it pays to be contrarian: who says the UK market has priced a stock precisely right, anyway?

Read more »

Investing Articles

The S&P 500’s 12% off its highs. Is now a good time to buy US shares for an ISA?

Right now, a lot of British investors are wondering whether it’s a good time to buy US shares. Here, Edward…

Read more »