Is Diageo a strong buy for its dividend growth?

Diageo dividend

Diageo (LON:DGE) (DGE.L) is a popular stock among UK investors. And that’s understandable, as the company is one of the largest alcoholic beverage manufacturers in the world, with an impressive stable of brands including Johnnie Walker, Smirnoff and Baileys. Diageo has also been a fantastic dividend growth stock in the past, increasing its dividend from 40.4p per share to 59.2p per share in the last five years alone.

So does that make Diageo a buy now? Let’s have a look.

Attractions

There’s no doubt Diageo has a lot going for it. Consumers purchase Diageo brands on a regular basis, through both the good times and the bad. This means that there’s an element of consistency to Diageo revenues, which is what I like to see from a dividend investing perspective. While revenue growth hasn’t been prolific over the last five years, increasing at a compound annual growth rate (CAGR) of just over 1%, analysts are forecasting revenue growth of 14% this year, with consensus estimates pointing to a top-line figure of £11,968m.

Diageo’s emerging markets exposure is another appeal of the company and CEO Ivan Menezes has stated in the past that “the future growth driver of the industry is the aspirational nature of the consumers in the emerging markets as their disposable income increases.” So there’s a long-term story at play here that could drive revenues higher going forward.

Low dividend yield

However, looking at the company’s trailing dividend yield of 2.55%, I’m just not convinced that now is the time to be buying the stock. While Diageo’s yield has been lower than this at times over the last five years, I’m convinced that with a little patience, opportunities to buy the stock with a higher yield will arise.

High valuation

Diageo’s valuation also suggests that the stock doesn’t offer strong value at present. The share price has enjoyed a formidable run over the last year, rising from around 1,750p to 2,324p today. With earnings of 105.5p estimated for FY2017, that places the stock on a forward looking P/E ratio of 22, a tad high for a company that has struggled to generate revenue growth recently.

Patience required

So looking Diageo’s dividend yield and valuation, I’m not seeing a great deal of value in the stock right now.

The FTSE 100 has enjoyed a strong run recently, and as a result, many blue-chip companies are trading at lofty valuations. However I’d be surprised if we don’t see some volatility in the near future, and that could present buying opportunities.

City analysts project a FY2017 dividend payout of 62.5p, meaning that if Diageo shares were to fall under 2,000p, a yield of 3.1% would be on offer. While still not a super high yield, that’s the kind of yield I would want to receive from Diageo.

So for now, I believe patience is required. Diageo has a lot of great attributes, but for me, the dividend yield is too low at present to warrant buying the stock for the dividend.

Disclosure: Edward Sheldon, CFA owns shares in Diageo. 

This article is provided for general information only and is not intended to be investment advice. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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