Stock market

Should I buy Diageo shares or leave them out of the barge pool?

Image source: Getty Images

What’s going on with Diageo (LSE DGE) shares now?

We are in a bull market and stocks are rising. But the premium alcoholic beverage purveyor is on a downward trend, and has been since late 2021.

This is not ‘understood’ with a standard business. And the company certainly is. It scores well against traditional quality indicators.

Quality at a price to match?

For example, the operating margin is around 27%. This compares to lower quality businesses, e.g Tescojust over 4%.

Diageo’s return on capital is around 15%. Meanwhile, Tesco can only manage a little over 8 percent.

Nevertheless, even Tesco has taken part in this bull run:

One of the problems is that Diageo has had a rich look for years.

Remember all the hype about so-called bond proxy trades?

When interest rates were at rock bottom for years following the credit crisis and the Great Recession of the 2010s, investors earned little on their cash reserves. Instead, they turned to companies with defensive operations and labeled them bond proxies.

Because operations were considered resistant to fluctuations in the broader economy, hedges were almost as reliable as putting money into bonds, the argument goes.

Was it all just another bubble?

Investors were all over these types of shares. Why? Because they believed that underlying businesses could offer predictable returns and sometimes higher yields than the bond market offers.

Other stocks that got caught up in the frenzy include the consumer staples group. UnileverSupplier of smoking products British American Tobacco and others.

The result for a decade around 2009 was a massive bull market for these defensive, bond-proxy stocks — and valuation expansion. Therefore, the price-to-earnings ratio increased as share prices increased.

Although the best things do come to an end. Now it looks like those stocks were in another bubble. In hindsight, they look as if they have been overvalued relative to their earnings growth rate.

Because of this, it looks like investors are likely to be selling shares. Events also conspired to lower prices. For example, interest rates are improving, making real bonds and cash accounts more attractive. Hence, there is now less need to invest in defense as a bond proxy.

On top of that, the pandemic made cyclical stocks look better in value, so some investors potentially moved out of defense and into them.

This scenario was repeated in 2023 at the start of the bull run starting last fall.

There are also wars, supply chain problems, inflation and other things. The common theme is that all these events have put pressure on overvalued stocks like Digeo and other one-time bond proxy darlings. And this is on top of any company/business specific issues they may have endured.

What will I do now?

Nevertheless, Diageo is still a great company and might make a decent long-term investment – at some point.

So, should I buy or not go anywhere near?

Well, I will never buy as long as the downward trend continues despite the improvement in value.

So, for now, I’ll dig in with deeper research and watch Diageo while keeping a safe distance from the shares. But this position can change quickly!

Source link

Related Articles

Leave a Reply

Your email address will not be published. Required fields are marked *

Back to top button