Warren Buffett‘s Berkshire Hathaway has recently taken a $41.3m stake in UK alcoholic beverage manufacturer Diageo, purchasing 227,750 shares — that’s what’s reported anyway. The disclosure was made in a Securities and Exchange Commission quarterly filing on Monday.
So should I follow Berkshire into Diageo?
Gen Re and Buffett
In this case, it’s not actually Buffett who has been buying Diageo. Gen Re is an insurance company owned by Berkshire Hathaway, but its investments aren’t controlled by Buffett. In its most recent report, Berkshire incorporated the investments of Gen Re’s portfolio into its own 13F filing.
It’s not clear whether Gen Re bought Diageo shares in the last quarter or whether it’s had these holdings for some time.
Diageo was the only UK stock in the Berkshire portfolio until recently when Buffett sold it. As we know, the legendary US investors buys value (companies trading at a discount versus their intrinsic or book value). And clearly, Buffett doesn’t see value in the company that owns brands such as Johnnie Walker, Guinness, Baileys, and Smirnoff.
Why does Gen Re own Diageo?
Gen Re can make its own investment decisions. And clearly the insurance company thinks it sees something that Buffett doesn’t. Diageo is a UK-based firm, but it’s not reliant on the UK economy. It’s a truly international firm, with upwards of a third of its sales ($6bn) in 2021 coming from North America.
What about Diageo?
Diageo is one of the more expensive companies on the FTSE 100, according to the price-to-earnings metric — that may have put Buffett off. The index average is around 13, while Diageo trades around 23.4 times earnings. So the company trades at a premium to the index.
Complete valuations aren’t achieved by looking at near-term metrics alone. Investors often use a discounted cash flow (DCF) calculation to develop a better idea of a stock’s fair value. However, DCF models aren’t simple. They require us making forecasts about a company’s cash flows many years into the future.
As noted above, Diageo owns dozens of household name brands and this provides it with defensive qualities — buyers tend to stick with the brands they know best even when times are tough.
But many of these brands are also highly desirable in developing parts of the world. This is one of the reasons why analysts see huge growth potential in Southeast Asia and Africa — this is one of the reasons why Diageo trades at a premium.
Another positive trend is Diageo’s premiumisation of its portfolio. The company has been focusing on the development and acquisition of premium products, which have higher margins and offer better protection against inflation than ‘value’ brands.
Is it right for me?
I’ve been following Diageo for some time. It’s certainly an attractive company with a promising growth picture. However, I’ve been waiting for good entry point and, recently, the share price hasn’t dropped far enough to entice me.
In the near term, with the pound appreciating, I’m expecting to see earnings decelerate in pound terms this year. A cost-of-living crisis may also take its toll on premium brand buying.
There could be a buying opportunity as a result — equally, this may already be priced in.
