Would Warren Buffett Buy Diageo?

LONDON -- There's a lot to be said for Diageo (LSE: DGE.L  ) (NYSE: DEO  ) . A resilient consumer-focused business, it has global brands, pricing power and a long history of delivering dividend growth.

In short, it's a FTSE 100 stalwart, and rightly so. And one, what's more, with some compelling characteristics.

So would Warren Buffett be interested in buying it?

Sage performance
After all, Buffett is one of the world's smartest-ever investors. Berkshire Hathaway -- the ailing textile company that Buffet bought into in the mid-1960s, and turned into a world-beating investment vehicle -- has delivered returns of over 20% per annum since 1965, and turned Buffett himself into the world's third-wealthiest person.

Given all this, many investors make the mistake of thinking that Buffett must use high-tech financial models and advanced discounted cash flow techniques to select the businesses that he buys into.

In fact, nothing could be further from the truth.

Moat
As Charlie Munger, Buffett's partner, once put it at an investors' meeting: "Warren often talks about these discounted cash flows, but I've never seen him do one."

"It's true," replied Buffett, acknowledging that to experienced eyes, a good share just looked like a good share. "It's sort of automatic ... It ought to just kind of scream at you that you've got this huge margin of safety."

So how does Buffett tell if a share would be a good pick? While a look at the financials certainly plays a part, it's a part that comes only at the end of multi-stage process -- a process that includes an early evaluation of that famous "moat" with which he's often associated.

As the man himself puts it: "In business, I look for economic castles protected by unbreakable 'moats.'"

In short, Buffett is looking for:

  • A business that he understands
  • Favorable long-term economics
  • An able and trustworthy management
  • A sensible price tag

So would Diageo pass the test? The company recently reported its full-year results, so I thought I'd take a look.

The fundamentals
Under a single banner, Diageo brings together some of the world's best-selling drinks brands. Johnnie Walker, J&B, Windsor, Bushmills, Smirnoff, Baileys, Captain Morgan, Tanqueray, and Guinness.

And those are brands with a provenance that reaches much further back than Coca-Cola, one of Buffett's own favorite tipples. J&B, for instance, dates from 1749, while Guinness dates from 10 years later, in 1759.

Roll the clock forward, and Diageo as we know it today actually came together during the investing lifetimes of many of us: the 1997 merger of Grand Metropolitan and Guinness PLC; and before that, the bitterly contested takeover of The Distillers Company by Guinness boss Ernest "Deadly" Saunders in 1986.

Today, Diageo employs over 20,000 people, has manufacturing facilities in Great Britain, Ireland, United States, Canada, Spain, Italy, Africa, Latin America, Australia, India, and the Caribbean, and its products can be quaffed in approximately 180 markets around the world.

And what's more, many of those products command considerable brand loyalty. Irrelevant? Not to Buffett, who sees loyal customers as part of that famous moat.

 

Year Ending June 30 2008

Year Ending June 30 2009

Year Ending June 30 2010

Year Ending June 30 2011

Year Ending June 30 2012

Revenues (billion pounds)

10.6

12.3

13.0

13.2

14.6

Pre-tax profit (billion pounds)

2.1

2.0

2.2

2.4

3.1

Earnings per share (pence)

64.4

69.7

72.0

83.6

94.2

Dividend per share (pence)

34.4

36.1

38.1

40.4

43.5

So would Buffett buy?
Over the last five years, Diageo has grown revenues by 8% a year, and pre-tax profit by 10% a year -- no easy feat in a recession, and eloquent testimony to that brand and pricing power. Over the same period, earnings per share have grown by 10% a year, and dividends by 6% a year.

Throw in the company's moat -- its market dominance, brand range and entrenched position in the minds of affluent consumers -- and the mix begins to look compelling.

So would Buffett buy Diageo, whose shares are changing hands at 1,720 pence today? Frankly, I don't think so: A historic price-to-earnings ratio of 17.4 is surely too rich, despite the attractions. The "margin of safety," in short, is too slim. Nor, at 2.8%, is the forecast yield attractive. That said, Diageo's share price occasionally stumbles, and a year ago, you could pick up the shares for 1,200 pence -- a 30% discount to today's price.

Follow the money
But even at that price, would Buffett buy Diageo? No one knows. What we do know, though, is that although he rarely ventures outside the United States for money-earning opportunities, one U.K.-listed share has caught his eye.

Its name? Simply download this free special report from The Motley Fool -- "The One U.K. Share Warren Buffett Loves" -- to find out. Inside, you'll discover just why Buffett has invested over 1 billion pounds in this business, of which he now owns over 5%, and why you could consider taking a stake, too.

Underperforming the FTSE by 20% over the past few months, the company trades on a prospective P/E of 9.3 -- well below the FTSE 100 average -- and offers a tasty 4.8% forecast yield. As I say, the report is free, and can be in your inbox in seconds.

Are you looking to profit as a long-term investor? "10 Steps to Making a Million in the Market" is the latest Motley Fool guide to help Britain invest. Better. We urge you to read the report today -- while it's still free and available.

More investing ideas from Malcolm Wheatley:

Malcolm Wheatley does not have an interest in any of the shares named. Motley Fool newsletter services have recommended buying shares of Diageo. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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