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Can Diageo Outperform Beam?

Thursday - 3/7/2013, 8:55pm  ET

LONDON -- If you're interested in building a profitable, diversified portfolio, then you will often need to compare similar companies when choosing which share to buy next. These comparisons aren't always as easy as they sound, so in this series, I'm going to compare some of the best-known names from the FTSE 100, FTSE 250, and the U.S. stock market.

I'm going to use three key criteria -- value, income and growth -- to compare companies to their sector peers. I've included some U.S. shares, as these provide U.K. investors with access to some of the world's largest and most successful companies. Although there are some tax implications to holding U.S. shares in a U.K. dealing account, they are pretty straightforward and I feel are outweighed by the investing potential of the American market.

Today, I'm going to take a look at drinks firm Diageo  and its US competitor Beam , which between them own many of the world's best known spirit brands.

1. Value
The easiest way to lose money on shares is to pay too much for them -- so which share looks better value, Diageo, or Beam?

ValueDiageoBeam
Current price-to-earnings ratio (P/E) 19.8 24.9
Forecast P/E 19.4 21.9
Price-to-book ratio (P/B) 7.9 2.1
Price-to-sales ratio (P/S) 4.5 4.0

Neither company can be described as a value investment, but based on historic and future earnings, Diageo looks more affordable than Beam. Beam's valuation may also be supported by its brand assets, however -- the company's shares trade at just twice their net asset value, which is a relatively low multiple compared to Diageo's lofty P/B of 7.9.

Overall, I would choose Diageo for value.

2. Income
With low interest rates set to continue for the foreseeable future, dividends have become one of the most popular ways of generating an investment income. How do Diageo and Beam compare in terms of income?

ValueDiageoBeam
Current dividend yield 2.3% 1.5%
5-year average historical yield 3.3% 2.3%
5-year dividend average growth rate 5.9% 8.8%*
2013 forecast yield 2.4% 1.5%

*Beam was spun off from former parent Fortune Brands in 2011; this figure has been calculated on dividends paid from 2011-2013.

Diageo looks the stronger choice for income -- its 2.3% yield is 50% more than Beam's 1.5% and Diageo has increased its dividend every year since 1999, providing a solid track record of growth.

Beam was only spun off from Fortune Brands in 2011, but my calculations show that since Beam became a dedicated spirits manufacturer, it has increased its dividend by an average of 8.8% per year, ahead of the increases delivered by Diageo. In addition, Beam's payout ratio -- the proportion of its earnings paid out as dividends -- was only 33% last year, considerably lower than Diageo's payout ratio of 43%, which suggests that Beam may have plenty of headroom for further dividend increases.

One downside of these companies' premium P/E ratings is that both have dividend yields below the averages for their indices; Diageo's 2.3% yield is well below the 3.2% average of the FTSE 100, while Beam's 1.5% does not compare well to the 2.2% average of the S&P 500.

3. Growth
Even if your main interest is value or income investing, you do need to consider growth. At the very least, a company needs to deliver growth in line with inflation -- and realistically, most successful companies need to grow ahead of inflation, if they are to protect their market share and profit margins.

How do Diageo and Beam shape up in terms of growth?

ValueDiageoBeam
5-year earnings-per-share growth rate 9.3% n/a
5-year revenue growth rate 7.5% n/a
5-year share price return 93.7% 47.3%*

*October 2011 to present.

Beam has only been an independent company since October 2011, making it impossible to gauge its earnings or growth sales record. However, investors have certainly been keen on the stock, and the company's share price has gained nearly 50% since its separation from Fortune Brands.

Diageo's track record of growth is excellent, and one key element of this success is its strong presence in emerging markets. Beam is more highly focused on U.S. and western markets, which I feel may inhibit its long-term growth potential.

Should you buy Diageo or Beam?
Diageo's share price has risen almost continuously since mid-2009, as have its earnings. The company's growth strategy does not yet seem to have run out of steam and if I was a growth investor, I might be prepared to invest in the hope of more to come. I am especially keen on Diageo's strong and growing presence in emerging markets, which offer far more growth potential.

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