Diageo (LSE: DGE) (NYSE: DEO.US) is a company that has done pretty well throughout the recession — booze is so handy for both celebrating in the good times and drowning sorrows during the bad ones, and brands like Johnnie Walker and Smirnoff are always popular.
Diageo kept its earnings and dividends rising right through the tough times, and the company’s defensive nature inspired a lot of investors to buy the shares. That in turn has pushed the price up 125% over the past five years to 1,878p, while the FTSE 100 has struggled to break 50%.
Valuation on the up
But we have seen Diageo’s price to earnings (P/E) ratio soaring too, from a slightly below-average 12.5 back in 2009, to 18 at year-end in June 2013. And with a modest 5% fall in earnings per share (EPS) forecast for this year, that multiple should rise to exceed 19.
Is Diageo really worth a higher valuation than the FTSE’s long-term average of around 14, and have the shares been pushed a little too high now? Some seem to think so, as the price has actually dropped back by 8% over the past 12 months while the FTSE has improved by a couple of percent.
What next?
So what’s in store over the next five years?
After this year’s mooted fall, there’s a return to steady annual earnings growth being predicted, and the City experts even suggest EPS could rise as high as 150p by June 2018. That’s nearly 50% more than 2013’s figure, and it would suggest a share price of around 2,700p should the current P/E valuation hold steady.
If that valuation were to falter and slip back to the average of 14, it would still suggest a 2018 share price of around 2,100. Not as impressive, but 12% up on today’s price — and without including dividends! And the City doesn’t seem to think there will be a downwards valuation of the P/E anyway, not with a pretty firm Buy consensus being offered right now.
What about those dividends then?
Cash to add to the pile
The latest forecasts trend suggests we could be adding around 300p on top of any share price rise. On the assumption that the P/E will remain above average, that would turn each 1,878p invested in Diageo shares today into a total of 3,000p in five years time.
That 60% return would be a pretty decent one from any stock, but it’s especially nice from a relatively low-risk investment like Diageo.