Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

This P/E Suggests Diageo plc (ADR) (DEO) Is a Hold

LONDON — The FTSE 100 has risen by 25% over the last year, and many top shares are beginning to look quite expensive. I’m on the hunt for companies that still look cheap, based on their long-term earnings potential. To help me hunt down these bargains, I’m using a special version of the price-to-earnings ratio called the PE10, which is one of my favorite tools for value investing.

The PE10 compares the current share price with average earnings per share for the last 10 years. This lets you see whether a company looks cheap compared to its long-term earnings.

Today, I’m going to take a look at the PE10 of drinks giant Diageo plc (ADR) (NYSE:DEO).

Diageo plc (ADR) (NYSE:DEO)

Is Diageo a buy?

Diageo plc (ADR) (NYSE:DEO) has been one of the great big-cap growth stories of the last 10 years. Since 2003, its share price has grown by 179%, and its dividend has increased by 69%, giving the firm an army of loyal shareholders.

However, I’m concerned that the company’s share price might have got slightly ahead of its earnings growth. Does the firm’s PE10 suggest underlying value, or is Diageo plc (ADR) (NYSE:DEO) ripe for rerating?

Trailing
P/E
PE10
Diageo 18.9 34

Diageo plc (ADR) (NYSE:DEO)’s PE10 of 34 reflects the firm’s strong growth, but I think Diageo is too large to be considered a pure growth play, and its trailing P/E of 18.9 looks quite expensive to me. Diageo’s prospective yield of 2.5% is below the FTSE average of 3.3%, and its share price has fallen by 5.6% over the last three months — nearly triple the 2% drop recorded by the FTSE 100 over the same period.

I think Diageo plc (ADR) (NYSE:DEO)’s share price may have peaked for now, and I expect that it may fall further this year, presenting an attractive buying opportunity. Although 18 of the 29 brokers polled by Reuters still rate Diageo as a buy, the firm’s third-quarter update was quite downbeat. I reckon that this year’s strong first-half growth is already factored into the price.

Hold Diageo

Diageo is an excellent company with market-leading products, high margins, and good long-term income prospects. However, it is expensive, especially when its net gearing of 122% is taken into account.

Diageo is on my own watch list, but I won’t be buying any of its shares until they are more reasonably priced — for now, I rate Diageo as a hold.

The article This P/E Suggests Diageo Is a Hold originally appeared on Fool.com and is written by Roland Head.

Roland Head has no position in any stocks mentioned. The Motley Fool recommends Diageo plc (NYSE:DEO) (ADR).

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Loading...