Unilever vs. Diageo: Diageo

In the competitive spirit of college basketball's annual championship tournament, The Motley Fool brings you Stock Madness 2007! Our writers are making head-to-head arguments for their chosen stocks (but not necessarily investment recommendations -- this is, after all, a game), and you'll pick the winners with your article recommendations and Motley Fool CAPS ratings. Who will win the right to cut down the net? Let's tip things off and find out!

Part of the fun of this little tournament is trying to figure out what my editor saw when putting together a given matchup. This one is easy. In Diageo (NYSE: DEO) and Unilever (NYSE: UL) (NYSE: UN), we have two European consumer-brand powerhouses that pay healthy dividends.

In fact, both are selections of our Income Investor service, and both have outperformed the market, with Unilever outperforming by 23% since being selected in March 2005 and Diageo outperforming by 24% since being selected in May 2004. Both are performances to be proud of, but I think Diageo is the better-run business and the better company to invest in.

In the world of consumer products, it's tough to beat Diageo's stable of brands in the alcoholic-beverage space and the company's laser-like focus on the industry. In its spirits arsenal, the company has brands such as Captain Morgan, J&B, Tanqueray, Jose Cuervo, and Smirnoff, the top spirit brand in the world. On the beer side of the business, there's Guinness, Harp, and Red Stripe. These are all brands bars want to have on hand, and they're brands people develop attachments to, for good or ill.

This strength shows up in Diageo's financials. Since selling off its non-core brands, Diageo's cash flow and returns on capital have increased dramatically, and the business model has become lighter. And as with other beverage companies, it doesn't take a great deal of revenue growth to generate healthy growth in operating income and earnings, because many of the costs are fixed. This allows the company to continue increasing its meaty dividend, which currently yields 2.9%.

The business is largely protected by the powerful distribution channel Diageo has built over the years, which ensures its brands will find their way to store shelves and is difficult for a competitor to build out and match. This distribution strength in spirits is similar to what Anheuser-Busch (NYSE: BUD) enjoys in the beer business.

In Diageo, you get a company focused exclusively on beverages, with leading brands that are well-known and sold globally. You also get a company that returns a large chunk of its earnings to shareholders. That's a tough proposition to beat.

Does this stock deserve to move on to the next round? If you think so, simply follow this link and rank the stock "outperform" in Motley Fool CAPS. If not, vote it "underperform." Later this week, we'll tally your votes to determine which stocks will advance one step closer to the title.

Click Unilever to read the opposing article in this contest, and click here to read all of the tourney entries.

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Anheuser-Busch is an Inside Value selection.

At the time of publication, Nathan Parmelee had no financial interest in any of the companies mentioned -- but that's nothing personal. He was ranked 44th out of 24,254 CAPS investors. The Motley Fool has an ironclad disclosure policy.