Should I Buy Diageo?

Weighing up Diageo.

Harvey Jones
Harvey Jones
Sep 17, 2012 at 12:00AM

LONDON -- It's time to go shopping for shares again, but where to start? Bombed-out bank RBS? Merger maniacs BAE Systems? Or maybe out-of-favor fashion giant Burberry?

There are plenty of great stocks to choose from, and I'm enjoying doing some window-shopping. So here's the question I'm asking right now. Should I buy Diageo (LSE: DGE.L)(NYSE: DEO)?

Drink up!
I first bought Diageo in May 2010, but it took me time to acquire a taste for this international spirits and brewing company. Despite it serving up a small measure of growth with a modest 3% dividend chaser, I still couldn't get excited about it. Still, I held on, thinking the odd drink can't do you any harm -- and I'm delighted I did. While other FTSE 100 stocks have had their weak moments, this well-run company has gone from strength to strength. It is up 50% over the last 12 months, while the FTSE 100 has grown less than 20%. I'll drink to that kind of success; the question now is: Do I want a top up?

Diageo packs quite a punch. It is truly a global company, operating in 180 countries, with a whole barrel of famous brands, including Johnnie Walker, Smirnoff, Baileys, Tanqueray, Captain Morgan, and Guinness. That's quite a drinks list.

2012 has gone very smoothly. Diageo posted pre-tax profits of 3.12 billion pounds in the 12 months to June 30, a rise of 32%, with revenue up 10% to 14.6 billion pounds.

That's good news for chief executive Paul Walsh. His performance-linked pay shot up to 11.2 million pounds this year, from a mere 4.4 million pounds last year, but unlike some executives, he is being rewarded for success rather than failure. Diageo is also the first major company to comply with the Coalition's demands for disclosing executive pay.

Thirsty work
European sales may have soured but this has been more than offset by thirsty emerging markets in Asia, Africa, and Latin America, which now make up 40% of Diageo's business. Net emerging market sales rose 15% and operating profits increased by more than 20%. By 2015, the company expects emerging markets to make up more than 50% of its business.

As I reported the other day, the Chinese may be thinking twice about splashing out on luxury brands such as Burberry, but in good times or bad, most people will still pay for one of life's little luxuries: alcohol.

This cash-rich company is also investing in its future. It is investing more than 1 billion pounds in the Scotch whisky renaissance, while Johnnie Walker is going down a treat in the U.S., where Diageo is nicely placed to benefit from a QE3-fueled recovery. Europe, where it still generates roughly one-third of its profits, is more of a worry.

A pricy round
It isn't all fun, fun, fun. The rising cost of raw materials, such as wheat and barley, could prove a downer, as could further gloom in Europe. The company also has significant foreign exchange exposure, a worry in this turbulent time for currencies.

My biggest concern is that Diageo is getting expensive. It now trades on a price-to-earnings ratio of 17.4 times earnings. Despite its progressive dividend policy, which included an 8% hike this year, the surging share price means that you are buying a modest yield of 2.6% (covered 2.2 times).

I'm delighted I ordered a slug of Diageo in 2010. But at these prices, I'm in no hurry to order another round.

Yield to the yield
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