When looking for dividend shares to buy, a track record of regular increases can catch my attention. However, on its own, that is not enough for me to decide whether or not to add a share to my portfolio.
Past performance is not necessarily a guide to what will happen. A business may have been a regular dividend grower but then decide to cut the payout as its business results made such increases harder to afford. That is exactly what Imperial Brands did in 2020, reversing a pattern of double digit percentage raises in the preceding years.
On top of that, valuation matters.
If a share looks overvalued, buying it could turn out to be a bad investment – and a high share price may mean the dividend yield is not especially attractive. Spirax-Sarco has grown its dividend each year for more than a half century. But its yield is a fairly meagre 1.6%.
By contrast, another FTSE 100 Dividend Aristocrat that has raised its payout annually for 36 years straight. After a 27% share price fall in the past year, it now yields 3%.
Solid business, strong profitability
The dividend share in question is Diageo (LSE: DGE). While the corporate name may sound obscure, it is the firm behind such well-known brands as Guinness and Johnnie Walker.
Owning premium brands like those gives the company pricing power. Demand is high and there is no direct substitute for many of the brands.
That pricing power shows through in Diageo’s large profits. Last year, for example, on turnover of £23.5bn the company reported post-tax profits of £3.8bn. Earnings at that level help explain the regular increases in the payout of this dividend share.
Challenging conditions
Why, then, has the Diageo share price tumbled? The past year has been a bad one but even over five years, the shares are 1% lower.
The company faces a range of risks to earnings. In many markets, fewer younger people are drinking alcohol. That could hurt future demand and revenues.
A trading statement in November pointed to significant commercial challenges in some markets. For example, the company pointed to “a materially weaker performance outlook in Latin America and the Caribbean”.
Difficult economic circumstances in many markets could hurt profitability in coming years, if cash-strapped drinkers stop splashing out on high-end tipples.
I’d buy
Still, I am a long-term investor. I reckon the long-term outlook for this dividend share remains strong thanks to its stable of iconic brands and deep industry experience.
A price-to-earnings ratio of 16 looks reasonable to me for this quality of company.
Dividends are never guaranteed, but I see Diageo as a solid business and would be surprised if it does not keep raising the payout annually in the coming years.
If I had spare cash to invest, I would be happy to add the shares to my portfolio.
