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Diageo‘s (LSE: DGE) share price has fallen 25% since 9 November 12 trading months to £32.68.
However, my starting point for evaluating whether any stock might be a bargain is the price-to-earnings (P/E) ratio.
In this case, the world’s largest spirits producer trades at 18.6, compared to a 19.9 P/E ratio for its rivals.
These include Rémy Cointreau on 17.4, Constellation Brands on 18.6, Pernod Ricard in 21.3, too Brown-Forman on 22.2.
So Diageo is cheap on this basis.
The same applies to its price-to-book ratio (P/B) where it trades at 3.6 compared to a peer average of 3.8.
To find out how profitable it is in cash terms, I did a discounted cash flow analysis. Using other analysts’ calculations and my own, this shows that the stock is 49% undervalued at the current price of £24.67.
This means that the fair value of the shares will be £48.37, although it could be lower or higher than that.
What does the dividend look like?
In its 2024 results, Diageo raised its dividend by 5% to 103.48 cents (79p) a share. This gives a current yield of 3.2%.
Analysts forecast the payout to rise to 80.8p in 2025, 84.7p in 2026, and 89.7p in 2027.
This would yield respectively a yield on the current share price of 3.3%, 3.4%, and 3.6%.
In the meantime FTSE 100 average yield is 3.6% and FTSE 2503.3%.
What are its growth prospects?
Ultimately, any company’s share price (and dividend) is driven by earnings growth.
Analysts expect Diageo’s earnings to grow by 1.5% annually through 2027. This is better than no increase at all, but it underscores to me management’s uncertainty about short-term benefits.
On November 10, the company issued a profit warning based on weak demand in the Latin American and Caribbean region.
This had never been flagged before and contributed to the steep price drop since that day.
2024 results released on July 30 also showed a year-on-year decline of 3% in organic Net sales for Diageo North America. This region accounts for 40% of its global sales.
The decline was attributed to the company’s weak consumer environment, and this is still the main risk for it, I think.
What is worse in my opinion is that there is no indication in the results of when these mild conditions may end. Earlier in the January 30 conference call, CEO Debra Crew indicated that the turnaround could take six to 18 months.
Is the stock a cheap investment for me?
Technically, Diageo is very profitable, which is good for me. Another is that it pays a reasonable dividend that is predicted to grow.
Right now though, I’m at a point in my investment cycle where I’m focusing on high yield stocks. The idea is that they can make enough assignments so that I can continue to reduce my work responsibilities and live off them.
Therefore, it is not something that I missed in my lifetime.
Even if I am 10 years younger, I would like to see clear growth strategies from the management before I consider buying it.
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