How Much Upside Is Left at Diageo plc (DGE)?

LONDON — Global premium-drinks company Diageo plc (LON:DGE) has been a stellar investment over the years. Does this big blue chip have much further to rise, or are its growth days over? Let’s have a look.

Track record
Diageo plc (LON:DGE) has delivered a storming performance for investors. In the last year, its shares have risen 30%. In the last five years, the shares have doubled. However, there are signs that this huge outperformance may be over. In the last three months, shares in this super-brewer have trailed the FTSE 100. While the FTSE is up 3.9%, Diageo is only 1.1% ahead.

What cannot be in doubt is Diageo plc (LON:DGE)’s quality as a company. Shareholder dividends have been increasing every year since 1998. In fact, the payout is up nearly fourfold in that time. Sales and earnings per share have also increased year on year for the last five years. Diageo is one of the U.K.’s most successful companies.

Valuation
Go back two years, and Diageo plc (LON:DGE) shares were trading around 1,300 pence. The company had just completed a year in which it earned 68.3 pence per share and declared a dividend of 38.1 pence. That put the shares on a historic price-to-earnings ratio of 19 and a past yield of 2.9%. In May 2011, shares in Diageo traded at 15.7 times the full-year EPS. The 2011 dividend equated to a 3.1% yield.

Brokers are forecasting 10.7% earnings growth in 2013, followed by an 11.1% rise next year. Dividend growth is expected to accelerate: An 8.6% dividend hike is expected, to be followed by a 10.5% rise next year. Shares in Diageo now trade on a historic P/E of 21.7, with a recent yield of 2.2%. According to the broker forecasts for 2013, Diageo plc (LON:DGE) sells on a current P/E of 19.6 and a 2013 yield of 2.3%.

Verdict
Although Diageo’s profitability has improved in the last two years, its valuation has also stretched significantly. This has pushed the yield lower, undermining the shares as an income investment. The shares trade on a P/E that puts Diageo in the top 20% of all FTSE 100 companies. Forecast earnings growth, however, is about average.

Given today’s bull-market conditions, I expect shares in Diageo plc (LON:DGE) to end 2013 about 10% higher than they are today.

The article How Much Upside Is Left at Diageo? originally appeared on Fool.com and is written by David O’Hara.

Fool contributor David O’Hara has no position in any stocks mentioned. The Motley Fool recommends Diageo (ADR).

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