Key points

• Diageo’s share price is down over 9% year to date.
• £2.3bn has been returned to shareholders from the company purchase of 61 million ordinary shares in 2022.
• In March 2022, a new canning industry was opened in Illinois, North America, with a capacity to produce 25 million RTD cocktails annually. 

While the stock market seems to be in a tailspin lately, Diageo Plc (LSE:DGE) shares appear to offer some refuge from the volatility. The stock has tumbled by around 9% since the start of 2022. But on a 12-month basis, it’s essentially been flat, excluding the extra passive income from dividends.

Zooming out even further reveals quite an encouraging sight. The global beverage enterprise has grown its share price by over 42% in the last five years. That vastly outperforms the FTSE 100‘s lacklustre loss of 7% over the same period.

Diageo shares have a dual listing on the London Stock Exchange in the United Kingdom and New York Stock Exchange in the United States, with the latter trading under the ticker (NYSE:DEO). But can the business maintain its upward momentum into the future? And is it a good investment for my portfolio? Let’s explore.

What does Diageo do?

Diageo is a leading alcoholic beverage business operating worldwide. It’s the creator and owner of many household brands, including Johnnie Walker, Tanqueray, Smirnoff, Guinness, and Baileys.

The company’s history dates as far back as 1887 when the Guinness group combined its hostile acquisition of Arthur Bell & Sons with Distillers Company. However, Diageo, as we know it today, wasn’t formed until over a century later, in 1997, following the merger of Guinness Group and Grand Metropolitan.

Since its humble beginnings, the company has evolved into a global alcoholic empire with over 200 brands sold in over 180 countries. It has a workforce of 27,987 employees worldwide, producing a wide range of alcohol-based beverages such as Gin, Rum, Vodka, Beer, Wine, and Whiskey, among others.

What is Diageo’s financial position?

Since the group is categorised as a “sin stock”, it doesn’t tend to gain much popularity with ESG investors. But it’s hard to deny that its products are popular amongst customers.

Even more so during times of economic turmoil, it would seem as if customers try to find solace in a bottle. Or at least, that’s the impression I’m getting when looking at its latest results.

In its 2022 financial report, the group delivered a strong performance in the face of an unprecedented political and economic environment. Net sales surged, pushing revenue growth to 21.4% to £15.5bn, while operating profit followed with an 18.2% boost reaching £4.4bn.

One key driver here is the recovery of its on-license trade. However, management did highlight strengthening organic growth as well. Subsequently, net cash from operating activities increased from £281m to £3.9bn.

Free cash flow to the firm was also admirable, landing at £2.8m. While this is slightly down from a year ago, it’s worth pointing out that in Diageo’s 2021 fiscal year, there was an exceptionally high working capital benefit that skews the comparison.

At the bottom line, earnings per share increased by 23.2% to 140.2p. And all things considered, things are looking rather positive. At least, that’s what I think. So what does this mean for the future of Diageo shares?

What is the future of Diageo shares?

At today’s share price of 3,556p, Diageo has a market capitalisation of £85bn. Meanwhile, its 52-week range lies between 3,283p and 4,110p.

That means Diageo stock is trading close to its 12-month average. But does that make the Diageo share price a fair valuation today?

Well, from a price-to-earnings PE ratio perspective, Diageo shares look a tad expensive trading at 26 times. By comparison, the market average is usually around 14 times earnings. However, some stock market analysts are still bullish on this business. And it’s not hard to see why.

Management has been executing some promising investments lately, including the expansion of its production facilities in North America and China with new whiskey distilleries. What’s more, in March earlier this year, a new canning factory opened its doors in Illinois, capable of producing over 25 million ready-to-drink (RTD) cocktails per year.

Furthermore, the firm continues to add new brands to its portfolio following the recent acquisitions of 21Seeds and Mezcal, Unión, and Vivanda – the owner of the flavour matching technology behind “What’s your Whisky” and “Journey of Flavour” at Johnnie Walker Prince Street in Edinburgh.

With so much progress being made, it’s not surprising that some broker forecasts are predicting Diageo shares could climb as high as 5,430p. Although, not everyone is convinced. In fact, the rapid pace of investment does open the door to problems if performance expectations aren’t met, with some forecasts placing their price target as low as 3,000p.

Investigating the risks

Beyond the internal investment risk I’ve just highlighted, the group does have its fair share of additional threats to contend with.

The ongoing geopolitical crisis in Eastern Europe has led to the closure of its Russian operations, with shipment and sales in the region grinding to a halt in March 2022. This was a small part of its global operation, so it’s not as damaging as many initially assumed. But it does highlight the problems that geopolitical situations can create.

However, the impact of inflation is a more pressing issue. So far, it seems the business is successfully passing on the increased cost of its beverage ingredients to its customers. In fact, profit margins have actually expanded slightly.

Whether it can continue to do that moving forward has yet to be seen. This is even more concerning regarding the state of energy prices. With more consumer capital being dedicated to paying skyrocketing electricity bills, the volume of drink sales could start to suffer moving forward.

Are Diageo shares good to buy or sell?

When making an investment decision, I like to look at a lot of factors to arrive at an informed decision.

Seeing high levels of institutional ownership is usually an encouraging sight as it signals strong confidence from the financial institutions that may also be willing to offer favourable financing options in the future when needed.

So, seeing that financial institutions own more than half of Diageo’s outstanding shares is a pleasant sight. Interestingly Black Rock Inc is currently the largest shareholder in this business, with a 7.6% stake.

Aside from the company’s ownership structure, I pay attention to the expected profitability and returns on my investment. Usually, companies reinvest excess cash or give it back to shareholders through dividend payments or share buybacks. And Diageo is no exception.

The company has a history of growing shareholders’ value and has increased full-year dividends annually since 2001. For the 2022 fiscal year, the recommended final dividend was increased by 5% to 46.82p per share. This brings the full-year dividend to a chunky 76.18p. On top of that, it also returned £2.3bn to shareholders through share buybacks.

All things considered, I think it’s fair to say Diageo is a good quality business. At least, that’s what I think. Does that make it a good investment? I’d say so, given the bullish sentiment from analyst forecasts. However, personally, an alcoholic beverage manufacturer doesn’t fit well with my ethical investing style. Therefore, I’m not interested in investing £1,000 into Diageo shares for my portfolio today.

Prosper Ambaka does not own shares in any of the companies mentioned in this article. The Money Cog has no position in any of the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.