Constellation Brands, Inc. (STZ), Diageo plc (ADR) (DEO): Drink Your Way To Profits With This Stock!

A cash generating machine

Over the last 10 years, returns on capital have been in the single digits, typically between 7% and 9%. Diageo plc (ADR) (NYSE:DEO) earned a 35% return on capital last year, and competitor Brown-Forman earned 38%. Constellation should be able to achieve that within two to three years. There’s definitely potential for better returns. With more profits and more cash, also come more share buybacks. Share buyback programs are a great indication of a shareholder-friendly company. Coke, for example, authorized a new buyback program six months ago. The company intends to buy back 500 million shares, valued at about $20 billion, as it returns cash to investors. In 2010, Constellation bought back $300 million of stock. In 2011, the board authorized an additional $500 million in share repurchases. Constellation expects to spend the $500 million over a multi-year period.

Valuation

While Brown- Forman trades at a hefty price-to-earnings of 22x and a price-to-sales of 5x, Diageo plc (ADR) (NYSE:DEO) is much cheaper. The giant brand owner trades at a price-to-earnings of 17x and a price-to-sales of 4x. Constellation is cheaper than both, trading at a price-to-earnings of 14x and a price-to-sales of only 3x.

Looking forward, the current P/E valuation of Brown- Forman is almost 20% greater than the company’s highest valuation mark in the past sixteen years. Since Brown- Forman is priced to perfection, it will be somewhat difficult for the company to maintain such a high multiple for years to come. As for Diageo plc (ADR) (NYSE:DEO), the company has reached a $2 billion deal for a 53.4% controlling stake in Indian-based United Spirits group, a decade after exiting the country’s market. This move is likely to give Diageo the grip that it needs so badly in Asia.

My Foolish conclusion

I believe that the market for branded wine and spirits is a great sector to be in. It’s relatively stable and recession proof. Constellation, with its cash generation, share buybacks, and market dominance, could very well become the leader of this sector over the next few years.

The article Drink Your Way To Profits With This Stock! originally appeared on Fool.com and is written by Shmulik Karpf.

Shmulik Karpf has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and Diageo plc (NYSE:DEO) (ADR). Shmulik is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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