Is Diageo The Ultimate Retirement Share?

Published in Company Comment on 23 August 2012

Will shares in Diageo help you build a FTSE-beating retirement fund?

The last five years have been tough for those in retirement. Portfolio valuations have been hammered and annuity rates have plunged. There's no sign of things improving anytime soon, either, as the eurozone and the UK economy look set to muddle through at best for some years to come.

A great way of protecting yourself from the downturn, however, is by building your retirement fund with shares of large, well-run companies that should grow their earnings steadily over the coming decades. Over time, such investments ought to result in rising dividends and inflation-beating capital growth.

In this series, I'm tracking down the UK large-caps that have the potential to beat the FTSE 100 (UKX) over the long term and support a lower-risk income-generating retirement fund (you can see the companies I've covered so far on this page).

Today, I'm going to take a look at drinks giant Diageo (LSE: DGE) (NYSE: DEO.US), which is the world's biggest spirits producer and owns brands such as Johnnie Walker, Smirnoff and Guinness.

Strong stuff

Diageo reported its 2012 results today, highlighting another year of decent growth with total sales up 6% and emerging market sales up 15%. The company has performed very strongly against the FTSE 100 over the last 10 years, as these figures show:

Total Return20072008200920102011Trailing 10 yr avg.
FTSE 1007.4%-28.3%27.3%12.6%-2.2%6.4%

Source: Morningstar

(Total return includes both changes to the share price and reinvested dividends. These two ingredients combined are what make it possible for equity portfolios to regularly outperform cash and bonds over the long term.)

Diageo's index-beating trailing 10 year average total return suggests that it has the potential to outperform the FTSE 100 over the long term and make a strong contribution to a retirement portfolio.

What's the score?

To help me pinpoint suitable investments, I like to score companies on key financial metrics that highlight the characteristics I look for in a retirement share. Let's see how Diageo shapes up:

Year founded1997*
Market cap£42bn
Net debt£6.6bn
Dividend Yield2.6%
5 year average financials
Operating margin27.7%
Interest cover6.0x
EPS growth9.4%
Dividend growth5.9%
Dividend cover1.9x

*Diageo was created when Guinness PLC and Grand Metropolitan merged.

Source: Morningstar, Digital Look, Diageo

Here's how I've scored Diageo on each of these criteria:

LongevityYoung company, old brands and products.3/5
Performance vs. FTSEStrong and impressive.4/5
Financial strengthHigh gearing offset by consistent high margins.3/5
EPS growthDecent in recent years but slowing (2% in 2012).3/5
Dividend growthBelow average yield but decent growth and payout ratio.4/5
Total: 17/25

A score of 17/25 is respectable and Diageo has the potential to deliver long-term capital and income growth and make a positive contribution to a retirement fund portfolio. At the same time, its P/E of 17.8 is relatively expensive and its 2.6% yield is well below the FTSE 100 average of 3.4% -- so anyone buying the share now needs a long-term view to reap the benefits of rising yield on cost.

Expert selections

Doing your own research is important, but another good way of identifying great dividend-paying shares is to study the choices of successful professional investors. One of the most successful income investors currently working in the City is fund manager Neil Woodford, who manages more money for private investors than any other City manager. Neil Woodford has delivered an impressive 347% total return -- and thrashed the wider market -- during the 15 years to 31 December 2011.

You can learn about Neil Woodford's top holdings and how he generates such fantastic profits in this free Motley Fool report. Many of Mr Woodford's choices look like excellent retirement shares to me and the report explains how he chose some of his biggest holdings.

This report is completely free and I strongly recommend you download"8 Shares Held By Britain's Super Investor" today, as it is available for a limited time only.

Warren Buffett buys British! The legendary investor has recently topped up on his favourite UK blue chip. Discover what he bought -- and the price he paid -- within our latest free report!

Further investment opportunities:

> Roland does not own shares in Diageo.

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Dylantherabbit 23 Aug 2012 , 12:10pm

Great share, bad price. DGE would need to fall significantly for it to be worthwhile buying into.

goodlifer 23 Aug 2012 , 12:48pm

"Bad price."

I'd buy at 12 times earnings or less.

ANuvver 23 Aug 2012 , 1:16pm

One of my largest and best performing core holdings (aggregate price of 12.4).

Not one for value or high-yield hounds at this price, I agree. But there are other views out there, and even if it looks toppy, it's still solid and the yield knocks so-called safe sovs into a cocked hat. I expect reasonable price support from institutional money.

This is one to look at when the four anchors of the Bloombergopalypse are hoofing around the lands.

When they're not acting like the four bimbos of the Facebook rapture, then suddenly turning into wise sombre fundamentalists, natch...

salmo365 23 Aug 2012 , 1:21pm

It's on my watch list and if the price falls I would love to buy. But its too toppy right now.

snoekie 23 Aug 2012 , 6:15pm

Just how many "ultimate" retirement shares can there be?

Seems to me you have over indulging on Diageo's products.

Given the times, seems to be the share is bound to yield, everyone are seeking solace from the product, and in good times they are toasting their success, but as we have seen govt rakes in more taxes, and keeps increasing the tax take to try and reduce the sales. Crazy huh?

goodlifer 25 Aug 2012 , 1:25pm


What's a sov?

ANuvver 25 Aug 2012 , 5:03pm

Sovereign bond. aka Bill, strictly speaking.

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