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LONDON -- When weighing up a potential investment, it's useful to look forward rather than backward. If you buy a stake in a business, it's the future profits that count -- and the stock market will value your shares based on future expectations.
With that in mind, it can be helpful to review what expert City analysts are expecting a company to earn in the coming years. These expectations can be compared to the share price, to give you a better idea of how the stock market is valuing the business.
Today, I'm looking at the earnings per share (EPS) forecasts for Diageo (LSE: DGE ) (NYSE: DEO ) , which owns the famous Smirnoff, Johnnie Walker, and Guinness brands. All my figures are courtesy of S&P Capital IQ.
Analysts expect Diageo to earn 1.03 pence per share this year. Which means that compared to today's share price of 2,018 pence, the market is valuing Diageo's shares on a forward price-to-earnings multiple of 19.5.
Out of 34 expert forecasts, the lowest estimate for 2013 profits comes in at 1 pound per share, while the highest is 1.12 pounds. With a fairly tight range, it seems analysts are confident in the stability of the Diageo's earnings.
The consensus then calls for consecutive years of growth in Diageo's profits, to 1.14 pounds per share in 2014 and then 1.26 pounds in 2015. This would represent annualized growth of 10% per year.
The data indicates Diageo's revenues could grow 7% annually over the same time period, from 10.7 billion pounds today to over 13 billion pounds by 2015.
These strong growth assumptions, factoring in improving margins and sales in emerging markets, explain why the market is happy to attach a strong "quality premium" to Diageo's shares. But are investors right to pay more for Diageo's iconic alcoholic brands, or is the market drunk on optimism?
Whether these projections and the current valuation make the shares of Diageo "fairly priced" is for you to decide.
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