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Diageo is a Top 10 Stock

Saturday - 11/24/2012, 9:20am  ET

Every portfolio should have a group of core holdings, stocks that the investor has the most confidence in and the intention to hold over the long term.  To continue a blog series that attempts to provide insight into each of the stocks in the "core" of my personal portfolio while providing some general insights into characteristics to look for when developing your own group of core holdings, today we take a more in depth look at the second largest holding in my portfolio, Diageo PLC , the worldwide leader in premium beverages.  Aside from providing portfolio diversity by operating in a completely different line of business than the largest holding in my portfolio, Diageo has a number of characteristics that make it a strong candidate for a core position in any portfolio.

A "Set It and Forget It" Stock

Very few companies are so stable and so well run that you can comfortably buy shares and feel confident that the long term performance will be so strong and predictable that you can ignore the company's results for 5 or 10 years without losing sleep.  I consider Diageo to be one of those stocks.   Diageo is tremendously diversified; the company owns a premier assortment of alcoholic beverage brands, including Johnnie Walker, Crown Royal, Smirnoff, Ketal One, Captain Morgan, Baileys, Jose Cuevro, Tanqueray, Guinness and many others (yes, that is nowhere near the entire list!).  Not only is the size and variety of its portfolio best-in-class, Diageo is a worldwide leader in part because it operates in 180 countries around the world and appeals to consumers at a range of price points.  The stability and predictability of Diageo's business model is a big reason that the company is a "core" holding in my portfolio; in addition, the spirits industry is an excellent hedge during recessionary periods and has frequently been noted to thrive as the overall economy struggles.  

In its 125 years of operation, Diageo has operated successfully through a well balanced mix of expansion of existing brands, acquisition of new brands as part of a long-time industry trend of consolidation, and expansion into new markets.  These three drivers of historical growth have generated fantastic shareholder returns in the past and will continue to drive profits in the future.  Speaking of the past, the 10 year chart for DEO shows just how impressive Diageo's results have been:

DEO data by YCharts

Not too shabby for the "boring" business of producing scotch and other beverages.  Add in a sizable dividend payout that has totaled $23.40 per share over the past 10 years, and investors have had many reasons to raise a glass to Diageo's management team.

The Thesis Remains the Same

Part of Diageo's remarkable stability is highlighted by the fact that the investment thesis hasn't changed since I first purchased shares about 6 years ago.  Diageo continues to hold a dominant posistion in a recession-resistant industry, which allows it to make stratgic acquistions while paying a considerable dividend; $23.40 per share paid back to shareholders over the past 10 years is pretty significant, as is the company's current dividend yield of 3.0%.  

While this alone might be reason to consider holding shares in Diageo, the best part is that the company can leverage its past success to generate future growth.  Growth comes from acquisitions, such as the recent acquisition of majority ownership in United Spirits, the largest producer of whiskey in India, for $2 billion. Growth also is generated organically, as evidenced by Diageo's announcement earlier this year that it plans to invest $1.5 billion expanding its scotch production capabilities.   These efforts to acquire and expand brands capture market share in established markets, but also put Diageo in a leadership position in emerging markets; with only 39% of Diageo's 2012 revenue generated in Asia, Africa and South America, there is plenty of room for continued growth.  In fact, management expects revenues from these markets to double by 2015. In short, there is no reason to doubt that the next 10 years will look a lot like the past 10 years for Diageo.

Why Diageo and Not a Competitor?

Many of the characteristics that make Diageo a "core" stock in my portfolio, such as the recession-resistant stability and emerging market growth opportunities, can be applied to Diageo's numerous competitors.  To be clear, there are a lot of companies large and small in Diageo's peer group that have generated positive returns for investors over the past 10 years.  For a similar balance of growth, stability and dividends, Brown-Forman  is a very strong alternative; Brown-Forman not only boasts a portfolio of strong brands such as Jack Daniel’s, Southern Comfort, Finlandia and Korbel, and it also resides on the prestigious list of 41 “dividend aristocrats” that have increased their dividend payouts for at least 25 years.  

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