Diageo Is Not That Strong Of An Investment Right Now

With shares of Diageo (DEO) down 11.8% from their 52-week high it is a great time to investigate what is going on with this stock that is in a personal correction. Diageo has been quite profitable for some investors over the past five years as the stock is up 22.7% in that timeframe, but it has been edging ever so slowly downwards since its peak in late 2013 as seen from the chart below. Not a good showing against an S&P 500 that has nearly tripled the returns over Diageo. Overall these vice stocks are great to hold during a recession because they continue to hold their own as the economy moves downwards, but it is important to examine the specific valuation, financial and technical situations of Diageo to see what is really going on with the stock.


The company currently trades at a trailing 12-month P/E ratio of 23.94, which is fairly priced, but I mainly like to purchase a stock based on where the company is going in the future as opposed to what it has done in the past. On that note, the 1-year forward-looking P/E ratio of 16.83 is currently fairly priced for the future in terms of the right here, right now. The 1-year PEG ratio (2.11), which measures the ratio of the price you're currently paying for the trailing 12-month earnings on the stock while dividing it by the earnings growth of the company for a specified amount of time (I like looking at a 1-year horizon), tells me that the company is expensively priced based on a 1-year EPS growth rate of 11.35%. The company also has great near-term future earnings growth potential with a projected EPS growth rate of 11.35%.


On a financial basis, the things I look for are the dividend payouts, return on assets, equity and investment. The company pays a dividend of 3.55% with a payout ratio of 85% of trailing 12-month earnings while sporting return on assets, equity and investment values of 8.2%, 28.3%, and 13.1%, respectively, which are all respectable values. Because I believe the market may get a bit choppy here and would like a safety play, I believe the 3.55% yield of this company is good enough alone for me to take shelter in for the time being.


(Click on image to enlarge)

Looking first at the relative strength index chart [RSI] at the top, I see the stock in oversold territory with a current value of 20.11 relative to the rest of the market. I will look at the moving average convergence-divergence [MACD] chart next. I see that the black line is below the red line with the divergence bars decreasing in height which tells me bearish momentum is in the name. As for the stock price itself ($104), I'm looking at 200-day simple moving average (currently $108.35) to act as resistance and $100.20 to act as support for a risk/reward ratio which plays out to be -3.7% to 4.2%.

Wrap Up

Fundamentally I believe the company to be fairly valued now on next year's earnings estimates and expensive on earnings growth expectations with great near-term earnings growth estimates. Financially the company does pay a good dividend and has decent financial efficiency ratios. On a technical basis, the risk/reward ratio shows me there is more reward than risk right now. To me, the trend appears to be downwards for now, but I do not think it will last for long.

I think the path of least resistance is to the downside for now and if you haven’t initiated a position in the name yet then maybe writing the December $100 puts is a great way to enter. The stock has been supported twice at $100 this year alone, once in January and the other time in June. By writing the $100 put an investor collects $1.40 in premium and if they want to use the proceeds to buy the $110 call for $0.85 I think that would be a great way to be long the stock. If the stock never sees the $100 mark and moves up an investor can cash in on the premium while perhaps make some money off the call option.

I actually initiated my position in Diageo in late September and have been pretty unhappy with the purchase thus far. So far, I'm down 61% on an annualized basis but will accumulate shares as long as they are below $108 because I believe that is where Diageo offers additional value. I've selected $108 because it is the average price of the 52-week range. Once it goes above $108 I would not make any additional purchases.

I swapped out of Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) for Diageo during the 2016 third quarter portfolio change-out because I was already heavy in technology stocks, ended up turning a profit in the name (2.1%, or 2.8% annualized), and wanted to lock in those profits. Since the swap, I have lost out, as Diageo has underperformed Alphabet since the swap. For now, here is a chart to compare how Diageo and Alphabet have done against each other and the S&P 500 since I swapped the names.

(Click on image to enlarge)

When it is all said and done, it matters what the stock has done in an investor's portfolio at the end of the day. For me, Diageo is one of my smaller positions and has been doing poorly, as I'm down 9.3% on the name, while the position occupies roughly 5.1% of my portfolio. I continue to believe in the name because the sin stocks should do well in good times and bad. I own the stock for the speculation portion of my portfolio, and I will continue to hold onto the stock for now. My portfolio is up 4.2% since the inception while the S&P 500 is up 0.4%. Below is a quick glance of my portfolio and how each position is performing. Thank you for reading and I look forward to your comments!

Company Ticker % Change Incl. DIV % of Portfolio
The Priceline Group Inc. PCLN 25.9% 6.2%
Southwest Airlines LUV 8.4% 11.6%
Electronic Arts EA 7.5% 4.0%
KLA-Tencor KLAC 6.5% 5.7%
Target TGT -2.2% 8.7%
AbbVie ABBV -8.4% 3.4%
Signet Jewelers SIG -8.9% 13.2%
Diageo DEO -9.3% 5.1%
Silver Wheaton SLW -10.1% 4.1%
Gilead Sciences GILD -14.7% 17.1%
Cash $ N/A 8.7%


Disclaimer: This article is in no way a recommendation to buy or sell any stock mentioned. This article is meant to serve as a journal for myself as to the rationale of why I ...

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Joe Economy 7 years ago Member's comment

Thanks for your interesting analysis of this alcoholic drinks producer. You mentioned that the 3.5% dividend yield is enough reason to buy this stock. I would be wary of that. Higher dividends are not always the best thing for an invester. Why? Because companies with lower dividends means that they are injecting profits back into the company rather than sharing the profits with shareholders. What factors are more important are if this company can remain competitive in a highly competitive consumer market place. Is there growth potential in the long term? How will the weakness of the British pound affect export revenues for this British company?

Ayelet Wolf 7 years ago Member's comment

I'm a firm believer that stocks like $DEO will do well during turbulent times and I think the next 4 years will be fraught with turmoil, regardless of who wins the election. But I haven't been happy with $DEO to date. What other sin stocks would you recommend instead?

Abba's Aces 7 years ago Contributor's comment

Thanks for reading AW... I haven't been looking at any other sin stocks per se but will let you know when I come across one!

Craig Newman 7 years ago Member's comment

Some interesting fundamentals here. But what does #Diageo do? Never heard of the company and that would have been good to mention in the article. I'm very particular about my vices :)


Dick Kaplan 7 years ago Member's comment

@[Craig Newman](user:7650), you've never heard of #Diageo?? They a global leader for alcoholic beverages. Easy enough to do a search, but you can learn more here: http://www.diageo.com/

Great article and thanks for bringing my attention to $DEO. Definitely worth taking a closer look.

Abba's Aces 7 years ago Contributor's comment

Thanks for reading CN and DK!

Gary Tanashian 7 years ago Contributor's comment

Glad to see a writer who highlights the losers along with the winners. Nice article and thank you for the integrity. BTW, that is some pretty good diversity in your port.

Abba's Aces 7 years ago Contributor's comment

Gary, thanks for the compliment and for reading!

Kurt Benson 7 years ago Member's comment

I agree, a very well written piece. Welcome to the site and I look forward to reading more by you. I've added you to my follow list.

Abba's Aces 7 years ago Contributor's comment

Thanks for reading Kurt!