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Legendary investor Warren Buffett has interest in Diageo (LSE:DGE) shares through a subsidiary of Berkshire Hathawayinvestment vehicle of which he is president, chief executive and largest shareholder.
But I think it's fair to say that the decision to buy shares in the drinks maker was not one of its best decisions. After purchasing a stake in the company during the first quarter of 2023, the share price has been in constant decline.
Since the beginning of 2023, it has fallen by a third. In November 2023, investors reacted poorly to a profit warning following a drop in sales in Latin America and the Caribbean.
Compared to the year ended June 30, 2023 (FY23), revenue in FY24 fell 1.4%. However, earnings per share were 11.8% lower. Unsurprisingly, this appears to have led to a loss of confidence in the company's prospects.
Don't panic!
But I suspect Buffett won't be too bothered by these developments. The American billionaire's philosophy revolves around long-term investment. He once described his favorite waiting period as “forever“. And advises “only buy something you would be happy to keep if the market closed for 10 years”.
Buffett's approach is to identify well-managed companies that are undervalued. This seems perfectly sensible to me. So should you also buy Diageo shares?
Reasons to buy
The first thing to highlight is that the sales of its most famous brand, Guinnesshave taken off in recent weeks. Influencers Lewis Capaldi and Jason Momoa, and a series of high-profile international rugby matches sponsored by the strong, have helped drive demand. Unfortunately, this means supplies to pubs across Britain have been restricted.
But the company has many other famous brands in its portfolio. In fact, it prides itself on offering something for everyone. For example, their six whiskeys range in value from $15 a bottle (Black and white) at $250+ (Johnnie Walker Blue Label).
The company has identified a trend in which consumers are “drink better, not more”. And given that 62% of its FY24 sales come from so-called premium brands, it should be well positioned to capitalize.
And the drop in its share price has helped reduce the stock's historical price-to-earnings (P/E) ratio to 17.9. There were more than 20 when Berkshire Hathaway acquired its stake.
Risks
But the company has many debts. As of June 30, its balance sheet revealed loans worth $21.5 billion. This is more than five times its FY24 cash inflow from its operating activities.
And its dividend isn't high enough to compensate me for the additional risk that would come with owning shares in a highly geared company. Based on its FY24 payout, the stock currently yields 3.3%. This is below the FTSE 100 average of 3.8%.
I am also concerned that 43 days before the November 2023 profit warning, company directors said the group was on track to meet its current forecast. This highlights the potential volatility of the drinks market. Less charitably, it could also suggest that Diageo's management team has limited visibility into the performance of the business.
At the moment, I don't find enough reasons to want to buy shares. Personally, I think there are better opportunities elsewhere.
