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When I heard that the Fool was planning to purchase 50 stocks over 50 days -- and wanted great ideas from analysts like yours truly (I advise the Fool's dividend service) -- I scanned the quiver of my Income Investor recommendations and shot British liquor company Diageo
Fast facts on Diageo:
Market Capitalization | $44.4 billion |
Industry | All things alcohol |
Revenue (TTM) | $14.7 billion |
Earnings (TTM) | $2.34 billion |
Return on Equity (TTM) | 39.7% |
Source: Capital IQ, a division of Standard & Poor's. TTM is trailing 12 months.
First off, I don't drink. That may sound weird, but it means I have no emotional connection with Diageo's leading brands: Smirnoff, Johnnie Walker, Guinness, and Captain Morgan, to name a few. And I mean a few: The company boasts eight of the world's 20 top liquor makes, altogether. You see, for me, investing is not about emotion; it's about coldly calculating odds for the best success, so the fact that I like a company despite its products is a green flag.
So why do I like Diageo in the first place, Fool? For starters, Diageo's big-ticket brands allow it to charge big-ticket prices – but for an affordable luxury like liquor, "big-ticket" is still small enough to be affordable for most folks. In developing markets, Diageo's liquors are actually status symbols that signal you've "made it." And developing markets have certainly "made" Diageo's growth story. Whereas developed-market operating profits have been flat to slightly down in the recession (still good considering alcohol is a nonessential good), those from emerging markets were up 16% for the last six months for which Diageo reported them.
Diageo's big brands do more than create future growth. They also drive Diageo's massive 40% return on equity – a measure of profitability per unit of equity dollar given to the company. That's one reason its shares have outperformed the S&P 500 by a dividend-adjusted 188% over the past decade.
Another is cash. I'm a sucker for it myself, and here, Diageo had me at "hello." A full 17% of its sales convert to free cash flow -- the purest measure of both company profitability and ability to pay dividends, better than Anheuser-Busch
A risk Diageo faces is its debt. Part of the reason it's maintained a strong ROE despite the recession is that debt has risen from 51% of capital to 66% of capital over the past five years. The company's operating income is 3.5 times its interest expense, so I'm comfortable with Diageo's debt, but it remains something to watch.
To hear James talk more about why Diageo is a great addition to your portfolio, watch his video on the company below:
On the positive side, investors have watched Diageo raise its dividend nicely since it began payouts 12 years ago. Diageo doesn't shoot for the moon here, but has maintained a payout growth rate of 5.4% annually over the past half-decade. It yields 3.2% at current prices, and U.S. investors will appreciate that there's no British withholding tax on U.S.-bound dividends. If you're looking for an international investment, it doesn't get much easier than Diageo.
On top of all this, Diageo sports over 20% of potential capital gain upside, according to my model. Combine that with its nice, growing yield, many of the world's top liquor brands, and robust free cash flow, and you've got a cocktail that should make any investor giddy – giddy in a good way.
Come back to Fool.com tomorrow for another great stock pick. There's plenty more great stock advice, and you can find video of each day's recommendation as well! To see the performance of previous recommendations, click here.
