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During the last decade, the Diageo (LSE:DGE) share price has nearly doubled. But there is more to Diageo shares as an investment than this.
The company also pays out a significant amount of its income to shareholders in the form of dividends. So how much would a £1,000 investment made 10 years ago be worth today?
investment returns
In January 2013, a £1000 investment in Diageo shares would have bought me 54 shares. Since then, the company has paid £6.29 per share in dividends to its shareholders.
By reinvesting my dividends along the way, I would have been able to increase my number of shares to 69. At current prices, that would mean my investment had a market value of £2,533.
That’s a return of £1,533, which equates to just under 10% per year. I think it’s a really good return and one that I would be happy with on any of my investments.
As an investor, the question for me is whether or not stocks can continue their impressive performance. A look at the underlying business leads me to think this is unlikely.
Profits
The first thing I notice is that the company’s stock price has been growing faster than its earnings. Diageo shares have risen from £18.43 per share in 2013 to £36.71 today.
That’s an average profit of just over 7% per year. By contrast, the company’s earnings per share rose from 97p to £1.40, an increase of just 3.75% per year.
That means a significant portion of Diageo’s share price gains are not due to growth in the underlying business. It is the result of investors being willing to pay higher prices.
I don’t see this as unreasonable investor behavior. Over the last decade interest rates in the UK have been low, justifying the rise in share prices.
Now, however, interest rates are rising rapidly. And I think this will mean that investors are not willing to pay such high prices for shares of companies like Diageo.
A stock to buy?
Diageo’s brand profile is absolutely stellar. Includes the best-selling gin (Gordon’s), the best-selling vodka (smirnoff), and the best-selling Scotch whiskey (johnnie walker).
I think this means that the company will consistently generate cash for its shareholders for years to come. And that could well be valuable in a downturn.
I also agree with Warren Buffett that it’s better to buy a solid company at a decent price than the other way around. But Diageo isn’t a stock I’m considering buying right now.
The company’s earnings have not kept pace with its share price over the last decade and that has left the stock somewhat inflated at the moment. That’s why I think there are better opportunities elsewhere.
