A fall in the share price doesn’t always mean that a stock is undervalued. Yet when a company that’s in the FTSE 100 loses half its value over the course of five years, it certainly raises the question as to whether the stock is appealing to buy. I decided it was time to revisit Diageo (LSE:DGE), to see if it now makes sense to consider buying.
A host of problems
Diageo has struggled over the past few years for several reasons. One major issue has been the slowing demand after the post-pandemic boom. During lockdowns and reopening periods, alcohol sales surged as consumers stocked up and socialised more. That created difficult comparisons for future years.
More recently, weaker consumer spending (especially in Latin America and North America) has hurt sales growth. The company also warned about softer trading in regions like Latin America due to inventory issues and slowing economic conditions.
It’s also true that younger consumers may be drinking less alcohol than previous generations. The rise of run clubs and health-tracking bands helps to highlight that the next generation would rather go out for a run than hit the bar. Obviously, this hasn’t been good news for Diageo.
And finally, it simply hasn’t been a fashionable stock lately. In a market obsessed with AI and high-growth technology companies, slow-and-steady consumer staples businesses have fallen out of favour.
The value play
Right now, the stock trades on a far lower valuation than it has historically. With a price-to-earnings ratio of 12.67, it’s below the FTSE 100 average of 16.3. So not only is the stock better value than it was in the past, but it’s also good value relative to the rest of the index.
Further, Q3 results published last week easily beat market expectations. Group organic revenue jumped 0.3% for the period, beating the 2.3% fall that people were forecasting. This might not seem like much to shout about, but for a battered stock, it could be the start of green shoots emerging.
The new CEO Dave Lewis is also talking up the prospects of a strong turnaround. In the update, he said “progress on the redesign of our new strategy and the shaping of a more competitive operating framework is well under way.” After all, alcohol consumption isn’t disappearing overnight. Premium spirits remain deeply embedded in social culture worldwide, and emerging markets could still offer significant long-term growth opportunities.
Not at the top of my list
I do struggle to justify this being the best value stock in the index. I believe that while it is undervalued, the trend could persist until we get more catalysts to suggest the turnaround under the CEO is really starting to yield results. The 5.14% dividend yield provides some useful income for those who hold the stock and are waiting for the share price to rally. Yet with the risks around consumer weakness serious (and potentially long-term), I think there are other value plays that I’m more confident about investing right now.
