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Throughout the 2022 bear market, Diageo stocks remained remarkably resilient. The beverage giant was boosted by the strength of its iconic brands such as Johnnie Walker, Guinness, Baileys, Smirnoffand Captain Morgan, along with the apparently inelastic or constant demand for alcohol. After all, economic crises may encourage people to drink furtherdespite having less money.
However, since then the economic clouds have begun to clear. The term “Soft landing” has become a common refrain. At the same time, Diageo shares have soared. Compared to its April 2022 high, the stock price is down 28%.
But I'm bullish on Diageo stock, because I think the market is underestimating the risk of a return to the good old days of 2022. I see reason to think that the US economy, which is so critical to global trade and stock markets , will fall. in recession. At the same time, I see a major factor threatening to fuel a resurgence in inflation.
Signs of recession and inflation concerns
The inversion of the yield curve, a reliable harbinger of US recessions, has been spooking investors since the summer of 2022. Despite this, the US economy has demonstrated remarkable resilience, with robust growth and job creation .
But that doesn't mean the U.S. economy is out of the woods yet. After all, yield curve inversion is a leading indicator. In other words, it flashes on the control board long before the problem arises.
At the same time, reports from the Panama Canal and the Suez Canal speak of trade disruptions that could cause a new rise in inflation.
The Panama Canal has narrowed due to drought, causing congestion and ship diversions. Meanwhile, the Suez Canal has seen traffic drop by 50% due to Houthi attacks on merchant ships. All of this means higher freight costs as insurance premiums rise and wait times for parts and products increase.
My theory is that a stagflationary environment would send investors back to defensive and value stocks, as was the case during 2022. To clarify, stagflation is when inflation is high at the same time that economic growth plummets.
Taking a look at the figures
Diageo's recent financial performance shows a picture of resilience and potential. With a price-to-earnings (P/E) ratio of 18, Diageo appears reasonably valued, especially compared to peers such as Coca Cola and PepsiCothat trade at higher multiples (24 and 29, respectively).
Furthermore, Diageo's latest interim results reveal a company that, despite facing challenges, particularly in the Latin America and Caribbean region, has managed to grow its net sales and operating profits organically in other key markets.
Is it time to buy?
I see companies like Diageo, which sell products with inelastic demand and brand loyalty, getting a boost in the event of stagflation.
Of course, if consumers really felt pressured, they might have no choice but to switch to knockoff brands to save money. At the same time, teetotalism is increasing among younger generations, reducing Diageo's potential market.
However, the company's strong portfolio of brands and proven ability to generate cash provide a cushion against downturns. I plan to add Diageo shares to my portfolio next time I have extra money.
