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%

7.5%

Fail

 

1-Year Revenue Growth > 12%

8.3%

Fail

Margins

Gross Margin >
35%

60.7%

Pass

 

Net Margin > 15%

18%

Pass

Balance Sheet

Debt to Equity < 50%

130.1%

Fail

 

Current Ratio > 1.3

1.52

Pass

Opportunities

Return on Equity > 15%

32.6%

Pass

Valuation

Normalized P/E < 20

25.41

Fail

Dividends

Current Yield > 2%

2.5%

Pass

 

5-Year Dividend Growth > 10%

5.9%

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 hasn't been able to regain the point it lost from 2010 to 2011. The stock has performed extremely well, though, rising nearly 40% over the past year.

Diageo isn't a household name, but its alcohol brands, which include Johnnie Walker and Baileys as well as Guinness, are well-known around the world. With both Johnnie Walker and Smirnoff cracking the top 100 brands in the world, Diageo clearly has its finger on the pulse of drinkers across the globe. Moreover, even though Brown-Forman's (NYSE: BF-B  ) Jack Daniel's tops Diageo's offerings, Diageo has given its shareholders substantial outperformance, beating out Brown-Forman's stock even though it lags behind beer giant Anheuser-Busch InBev's (NYSE: BUD  ) and its Budweiser brand. Moreover, even with Beam (NYSE: BEAM  ) paying a new dividend, Diageo still tops it in the yield department.

Increasingly, Diageo has focused on emerging markets as an area to capitalize on big growth potential. For instance, Asia is a largely untapped market, and Diageo has top billing there in terms of sales as well as in Latin America and Africa. Yet even with substantial beer consumption in Asia, neither Anheuser-Busch nor Molson Coors (NYSE: TAP  ) has worked very hard to try to crack the market.

Diageo isn't afraid of making big strategic moves as well. A couple of months ago, the company was reportedly in talks to spend $3 billion to acquire Jose Cuervo. Although those talks haven't resulted in a solid deal yet, consolidation within the industry appears likely to continue its rapid pace, and Diageo is smart to stay in the thick of it.

In its most recent quarter, Diageo saw continued strength. Organic sales growth slowed, but huge gains in Latin America and the Caribbean were able to outweigh a slight contraction in Europe.

For Diageo to improve, it needs to boost growth and get earnings up to justify its somewhat pricey valuation. Given time, though, Diageo has the potential to get a lot closer to perfection in the future.

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.

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

Fool contributor Dan Caplinger has no positions in the stocks mentioned above. The Motley Fool owns shares of Beam. Motley Fool newsletter services recommend Beam, Diageo, and Molson Coors. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.


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