If I’d invested £500 in Diageo shares 2 years ago, here’s how much I’d have now!

Diageo (LSE:DGE) shares tanked this week despite beating analysts’ estimates in the half-year review. The drinks manufacturer fell by around 8% in the week, and the same over 12 months.

The stock is the only British company held by legendary investor Warren Buffett. It’s a small holding, but of course this says a lot about the stock. After all, Buffett has an excellent track record for picking winners.

So let’s take a closer look at this beverage giant, and find out if the investment in Diageo two years ago will be a success.

Focus on growth

Diageo is more growth-oriented than most stocks FTSE 100. The stock only offers a measly 2.2% dividend.

So if I had invested £500 in Diageo two years ago, today I have about £580. The shares have surged 16% despite the recent collapse.

Adding the small dividend payments I will receive during that time, the yield will be quite strong – close to 20%.

Evaluation

Diageo trades at a higher multiple than most indices, and this is due to its growth potential. The stock has a price-to-earnings ratio of 23.

A discounted cash flow calculation, based on a 10-year investment, suggests the stock is undervalued by around 25%. That is clearly positive, but it should be noted that forecasting future cash flows over the next 10 years can be challenging.

It is also worth highlighting that while the dividend is small, it is strongly supported by earnings, with a cover of 3.2 times.

Is it worth it?

Is Diageo worth the multiple it is trading at? Well, that’s a big question.

Short-term growth has been impressive. In the six months to the end of 2022, the company’s operating profit increased by 15.2% to £3.2bn. Meanwhile, organic operating profit, excluding acquisitions and currency fluctuations, rose 9.7%. Diageo benefited from the price hike and so did premium spirits drinkers.

The group now says it expects to achieve organic net sales of between 5% and 7%, and sustainable organic profit growth of between 6% and 9%, for 2023 to 2025.

In the long run, the company’s prospects can be attributed to the brand it owns. Johnnie Walker, Guinness, Baileysand Smirnoff providing defensive qualities, but it is also worth noting that this product line also appeals to a change in the developing economy where the brand takes more than a status symbol.

What is it for me?

Diageo is a truly international company, with more than a third of its sales ($6bn) in 2021 coming from North America. This is definitely a positive as the risk is spread around the world. Especially now, with the forecast down in the UK.

Slow economic growth, especially in the UK, could affect alcohol sales this year. However, once again, brands have defensive qualities, so they are difficult to predict.

I’ve been toying with buying Diageo shares for a while. But I see this current decline as a good opportunity to buy. So, I want to add this stock to my portfolio.