Has Diageo Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Diageo (NYSE: DEO  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Diageo.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

6.5%

Fail

 

1-Year Revenue Growth > 12%

1.6%

Fail

Margins

Gross Margin > 35%

59.6%

Pass

 

Net Margin > 15%

19.1%

Pass

Balance Sheet

Debt to Equity < 50%

138.2%

Fail

 

Current Ratio > 1.3

1.46

Pass

Opportunities

Return on Equity > 15%

37.5%

Pass

Valuation

Normalized P/E < 20

21.51

Fail

Dividends

Current Yield > 2%

3.1%

Pass

 

5-Year Dividend Growth > 10%

5.4%

Fail

       
 

Total Score

 

5 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Diageo last year, the company has lost a point on our 10-point scale. The company's earnings multiple has moved out of our attractive zone, and a slowdown in revenue growth offsets a nice gain in net margins.

Diageo is the company behind many popular brands of liquor, including Johnnie Walker, Tanqueray, and Smirnoff, as well as Guinness beer. With global reach, the company has nearly 20% of the world's top 100 brands of spirits.

For investors, though, Diageo gives its shareholders an even more pleasant buzz. The company's margins are extraordinary, topping both liquor-focused Constellation Brands (NYSE: STZ  ) and Beam (NYSE: BEAM  ) as well as beer makers Anheuser-Busch InBev (NYSE: BUD  ) and Boston Beer (NYSE: SAM  ) .

One new development bears watching, though. Now that Beam has split off from Fortune Brands Home & Security (NYSE: FBHS  ) , some believe that Beam could be a takeover candidate. The bourbon maker would let Diageo compete better against Brown-Forman (NYSE: BF-B  ) and its Jack Daniel's brand.

Longer term, Diageo has been able to put together the solid fundamentals that make for a great pick for buy-and-hold investors. With some work to stoke growth and get its debt under better control, Diageo could make a run for perfection very soon.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate the best investments from the rest.

Click here to add Diageo to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Diageo and Boston Beer. Motley Fool newsletter services have recommended buying shares of Diageo, Beam, and Boston Beer. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

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