I like companies that are market leaders, have plenty of growth ahead, and are gaining market share. Diageo fulfills all of these criteria and also possesses a strong competitive advantage, which should enable it to perform well in all economic environments. Is now the right time to add Diageo to your portfolio? This is what I will investigate in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
For full disclosure, I should mention that at the time of writing this analysis, I do not own any shares in Diageo. If you would like to copy my portfolio or view the stocks in my portfolio, you can find instructions on how to do so here. I don't own shares in any of their direct competitors either. I should also mention that Diageo has been on my watchlist for years, so it is a company that I like. Nonetheless, I will keep this analysis unbiased. Diageo is listed in both the United States and the United Kingdom. In this analysis, the numbers and calculations will be in British pounds. If you prefer to buy the U.S.-listed ADRs, you should remember that each ADR consists of 4 ordinary shares. You can purchase both U.S.-listed and U.K.-listed shares or fractional shares on eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $50.
The Business
Diageo, established in 1997 from the merger of Guinness plc and Grand Metropolitan, is a key player in the global beverage alcohol industry. Headquartered in London, Diageo offers a vast portfolio of over 200 well-known brands across spirits and beer, including iconic names like Johnnie Walker, Guinness, Baileys, Tanqueray, and Smirnoff. Its products are distributed in more than 180 countries, reaching diverse markets worldwide. North America, accounting for 39 percent of total net sales, represents Diageo’s largest market, followed by Europe at 24 percent, Asia Pacific at 19 percent, and Latin America, the Caribbean, and Africa, each contributing 9 percent. Diageo’s competitive advantage lies in its combination of an extensive portfolio, geographic reach, and focus on efficiency. With some of the most recognized brands in the industry, Diageo benefits from a robust "brand moat" that secures strong consumer loyalty and pricing power. This brand strength is crucial in maintaining a competitive position across both premium and accessible market segments. Johnnie Walker, the top international spirits brand by retail value, and Guinness, one of the most celebrated stout brands, exemplify the impact of Diageo’s heritage and branding expertise. Diageo’s broad geographic presence supports resilience in times of regional economic volatility. By operating in the world’s largest economies, such as the United States, alongside emerging markets like China and India, Diageo can mitigate regional risks and capitalize on growth opportunities. Pricing flexibility across Diageo’s portfolio is another major strength, allowing the company to cater to a variety of consumer preferences and economic conditions. With brands spanning different price points, Diageo effectively attracts consumers across income levels, whether they are seeking entry-level options like Smirnoff or high-end selections such as Don Julio. This ability to address diverse market segments drives profitability and provides stability as consumer demand shifts.
Management
Diageo’s CEO is Debra Crew. She joined Diageo in 2020, initially serving as the President of Diageo North America. She later assumed the role of COO before being appointed CEO in June 2023. Prior to joining Diageo, she held various roles at companies such as Mars, Nestle, Kraft Foods, PepsiCo, and Reynolds American. She also serves on the Board of Directors at Stanley Black & Decker. Debra Crew holds an MBA from the University of Chicago Booth School of Business. Debra Crew was appointed CEO of Diageo due to her impressive track record, extensive expertise in the consumer industry, proven strategic capabilities, strong operational performance, and her evident ability to build and lead teams. In her first letter to shareholders, Debra Crew stated that she will focus on continuing to gain market share through premiumization and active portfolio management. It seems she intends to continue Diageo's successful strategy, which is encouraging. While it is too early to judge Debra Crew’s impact, I am encouraged by her extensive experience and her commitment to sustaining the strategy that has proven effective for Diageo in recent years.
The Numbers
The first metric I will investigate is the return on invested capital (ROIC). Ideally, ROIC should be above 10% each year. Diageo has consistently achieved a solid ROIC above 10% annually, even during fiscal year 2020 amid the pandemic. It is encouraging to see that Diageo achieved a ROIC above 15% in two out of the past three years. ROIC decreased slightly in fiscal year 2024, which has been a particularly challenging year for spirits companies due to high inventory levels following the pandemic. Nonetheless, Diageo still managed to achieve a ROIC above 13%, which is impressive. I expect that ROIC will reach 15% again once inventory levels normalize. Another aspect I appreciate is that the Chairman of the Board, Javier Ferran, highlighted ROIC in his letter to shareholders. He explained that their investment philosophy may sometimes have a short-term impact on ROIC, indicating that volatility in ROIC shouldn’t be a concern.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Equity has decreased since 2018, but it isn’t something I’m worried about. The decrease is primarily due to Diageo’s sale of 19 brands to the Sazerac Company. Diageo’s consistent acquisitions and divestitures of brands mean that its equity will continue to be volatile, so I’m not concerned about occasional decreases in equity.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It’s not surprising that Diageo has achieved positive free cash flow every year for the past decade. Free cash flow has decreased over the past two years due to external factors such as macroeconomic conditions and high inventory, as well as increased capital expenditures over the past three fiscal years. For instance, Diageo has started constructing a second brewery for Guinness in Ireland to meet the growing demand for Guinness 0.0 and a new distillery for single malt whiskey in China. The high capital expenditures have also impacted the levered free cash flow margin, which has been lower than usual in the past two years. Normally, I would find this concerning, but the increase in capital expenditures should be temporary. Management has mentioned that they expect capital expenditures to remain elevated through fiscal years 2025 and 2026, after which they should return to historic levels, improving both free cash flow and the levered free cash flow margin. The free cash flow yield is currently above the ten-year average, suggesting that Diageo is trading at a more favorable valuation than usual; however, we will revisit this in more detail later in the analysis.
Debt
Another important aspect to consider is the level of debt, and it’s crucial to determine whether a business has a manageable debt level that can be repaid within a 3-year period. This can be assessed by calculating the ratio of long-term debt to earnings. In Diageo’s case, the debt-to-earnings ratio is 4,81 years, which exceeds the 3-year limit. While this is slightly higher than I would like to see, and not yet alarming, it is something that needs to be monitored.
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Risks
Like any other investment, there are risks associated with investing in Diageo. One significant risk is macroeconomic conditions. Macroeconomic factors present considerable risks to Diageo’s financial performance and growth, as they directly influence consumer spending habits and the company’s cost structure. Operating globally, Diageo faces diverse macroeconomic challenges across its key markets, including North America, Europe, and emerging regions. Economic uncertainty, high inflation, and elevated interest rates are leading consumers to exercise caution in their discretionary spending. Even those with disposable income are showing restraint, which can reduce demand for Diageo’s premium and mid-tier brands. Since Diageo’s products are often considered non-essential, economic downturns may shift consumer preferences away from premium choices or lower overall consumption, ultimately impacting sales and profitability. Retailers are also likely to be more conservative with their inventory management in this economic environment, as high interest rates and uncertainty affect their willingness to hold large stock levels. This caution can reduce the pace at which Diageo’s products are reordered and stocked, potentially leading to slower sales volume growth and limiting Diageo’s ability to maintain or expand market share in certain areas.
Competition presents a significant risk for Diageo, as it operates in a highly saturated market for both spirits and beer, where product quality, pricing, and brand positioning are essential. Diageo competes with several large global brands, including Pernod Ricard, Beam Suntory, Bacardi, and Brown-Forman in spirits, and AB InBev, Molson Coors, Heineken, Constellation Brands, and Carlsberg in beer. Each of these competitors has strong brands targeting similar consumer segments, putting pressure on Diageo to continually differentiate its offerings and maintain customer loyalty. A major source of competitive pressure for Diageo is the rise of e-commerce, which is reshaping traditional distribution networks and often requires digitally focused strategies to reach consumers. This shift may drive Diageo to increase spending on online promotions and digital marketing to retain market presence. Competitors, especially agile craft brands, have quickly embraced e-commerce, appealing to niche markets and fostering strong online engagement. To avoid losing market share, Diageo must continuously innovate and strengthen its digital presence. Additionally, distributor consolidation adds complexity, increasing the bargaining power of large retailers who can negotiate lower prices or limit price increases. This may restrict Diageo’s ability to adjust pricing in response to rising costs, potentially eroding margins over time.
Emerging headwinds are increasingly becoming a risk for Diageo, as changing industry trends challenge the traditional alcoholic beverage market. One major factor is the rise of GLP-1 drugs, originally developed for diabetes and weight loss, which appear to reduce alcohol cravings among users. If the use of these drugs continues to grow, Diageo may see reduced consumption across its brands, as fewer people feel the desire for alcoholic beverages. Another significant challenge comes from the increasing prevalence of cannabis, particularly among younger consumers like Gen Z. This generation is adopting cannabis at double the rate of previous generations and is also drinking less alcohol overall. Combined with Gen Z's preference for health-conscious lifestyles and interest in sober or low-alcohol options, this shift could reshape the beverage industry. As more young people prioritize wellness, they are driving demand for non-alcoholic and functional beverages that promise relaxation or energy without the effects of alcohol. These cultural and generational shifts pose a fundamental risk to traditional alcoholic products, as they could erode the customer base that Diageo has historically relied upon.
Reasons to invest
There are numerous reasons to invest in Diageo. One key reason is premiumization, which aligns with shifting consumer preferences and drives long-term value growth in the spirits industry. The premiumization trend reflects a shift in consumer behavior, where individuals are increasingly choosing to drink “better, not more.” This shift has led to a significant increase in demand for high-quality, premium, and super-premium spirits over the past decade, with premium and above spirits now making up almost 35% of the category’s value, up from 26% ten years ago. The super-premium plus price tier, in particular, has been growing more than twice as fast as other price segments, gaining significant market share in international spirits retail sales. Diageo is well-positioned to benefit from this trend due to its extensive portfolio of premium brands, including scotch and tequila, which are popular in super-premium categories. In Diageo’s largest market, the U.S., premium and super-premium segments have been the primary drivers of growth, showing strong resilience even in challenging economic conditions. This premiumization trend remains a tailwind for Diageo, as its premium brands gain share in key markets like the U.S. and scotch markets globally. Diageo’s portfolio, structured across a diverse price ladder, allows consumers to “trade up” within its offerings, capturing growth from the shift toward higher-quality products.
Portfolio optimization through strategic acquisitions and divestitures is a compelling reason to invest in Diageo, as it enhances the company’s ability to focus on high-growth, premium brands while shedding non-core assets that do not align with its long-term strategy. In recent years, Diageo has expanded its portfolio by acquiring brands with strong growth potential, such as Don Papa Rum, Balcones Distilling, Mr. Black, and full ownership of DeLeon tequila. These acquisitions strengthen Diageo’s presence in high-demand premium categories, particularly in rum, whiskey, and tequila, where consumer interest is steadily increasing. At the same time, Diageo has demonstrated discipline by divesting brands that do not fit its strategic goals, such as Pampero and Safari. This targeted divestment approach allows Diageo to concentrate on high-margin brands. Diageo’s active approach to portfolio management also supports its capital allocation strategy. By exiting low-growth, non-core brands, Diageo can reduce leverage, increase EBITDA margins, and improve profitability, strengthening its financial position. This disciplined, forward-looking approach to acquisitions and divestitures ensures that Diageo remains agile, focusing on brands aligned with consumer trends. By refining its portfolio with strategic additions and exits, Diageo positions itself for sustainable long-term growth.
Guinness is a compelling reason to invest in Diageo, driven by consistent growth, expanding consumer appeal, product innovation, and an efficient, capital-light model. In fiscal 2024, Guinness delivered 15% organic net sales growth across core markets, including Great Britain, Ireland, and the U.S., attracting not only its traditional base but also a broader audience, particularly women and younger consumers. Innovation has fueled this success, with Guinness 0.0, the non-alcoholic variant, meeting the rising demand for moderation. Guinness 0.0 has quickly gained popularity, doubling its net sales in Europe and becoming the UK’s best-selling non-alcoholic beer, even surpassing Heineken 0.0. To meet this demand, Diageo has invested €25 million in expanding production capacity for Guinness 0.0, projecting nearly a 300% increase in global production. Guinness’s asset-light model boosts profitability by focusing production in Ireland and using partnerships in markets like Nigeria instead of building multiple facilities. This approach lowers costs since Diageo doesn’t have to invest heavily in maintaining breweries worldwide. By saving on infrastructure, Diageo can allocate more resources to profitable activities like brand building, marketing, and new product innovation. With fewer fixed costs and greater flexibility, Diageo can quickly adapt to changing demand, making the Guinness business scalable, efficient, and highly cost-effective.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 1,37, which is from fiscal 2024. I have selected a projected future EPS growth rate of 10%. (Finbox estimates EPS to grow by 1,4%, but EPS has grown at 18,5% in the last 5 years). Additionally, I have chosen a projected future P/E ratio of 20, which is twice the growth rate. This decision is based on the fact that Diageo has historically had a higher P/E ratio. Lastly, our minimum acceptable rate of return is already set at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of £17,57. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Diageo at a price of £8,78 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 3.247, and capital expenditures were 1.195. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 837 in our calculations. The tax provision was 1.024. We have 2.222 outstanding shares. Hence, the calculation will be as follows: (3.247 – 837 + 1.024) / 2.222 x 10 = £15.45 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Diageo's Free Cash Flow Per Share at $0.92 and a growth rate of 10%, if you want to recoup your investment in 8 years, the Payback Time price is £11.57.
Conclusion
Diageo is an intriguing company, as its brands give it a strong moat. There are some uncertainties regarding management, as the CEO is still new. Diageo has delivered lower ROIC and free cash flow over the past two years, but this is due to higher capital expenditures, which should result in long-term growth. Macroeconomic challenges like high inflation, elevated interest rates, and economic uncertainty pose risks for Diageo, as cautious consumer spending can reduce demand for its premium brands. Additionally, retailers’ conservative inventory practices in such an environment may slow product reordering. Competition is a risk for Diageo, as it operates in a crowded market against strong global and craft brands, requiring constant innovation and marketing investment to retain customer loyalty. The rise of e-commerce and retailer consolidation also increases pressure on Diageo to adapt its digital strategy and limits its pricing flexibility, potentially squeezing margins. Emerging headwinds, such as the growing use of GLP-1 drugs that reduce alcohol cravings and Gen Z’s shift toward cannabis and health-conscious, low-alcohol lifestyles, pose a risk for Diageo by potentially decreasing demand for traditional alcoholic beverages. Premiumization is a compelling reason to invest in Diageo, as the trend toward "drinking better, not more" is driving long-term growth in premium and super-premium spirits, which now represent a growing share of the market. Diageo’s extensive portfolio of high-end brands positions it well to capitalize on this shift. Portfolio optimization through strategic acquisitions and divestitures enables Diageo to focus on high-growth, premium brands while shedding non-core assets. This disciplined approach strengthens Diageo’s presence in high-demand categories, improves profitability, and supports sustainable long-term growth aligned with consumer trends. Guinness is a valuable asset for Diageo, showing strong growth through expanding consumer appeal, successful innovations like Guinness 0.0, and a capital-light model that boosts profitability. I believe that Diageo is a quality company, and I will buy shares at the Ten Cap price of around £16, and possibly even a smaller position at a higher price.
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