Could the Diageo share price help you retire earlier?

The Motley Fool
Senior couple at the lake having a picnic
Senior couple at the lake having a picnic

The market remains shaky ahead of this week’s Brexit vote. But one stock that hasn’t been affected by the uncertain outlook in the UK is spirits giant Diageo (LSE: DGE), which owns brands including Smirnoff, Gordon’s and Johnnie Walker.

This FTSE 100 firm is popular with long-term investors thanks to its high profit margins, valuable brands and continued growth. So far this year, it’s outperformed the FTSE 100 by about 15%.

Bargain-hunting investors may point out that Diageo rarely looks cheap. However, I think there’s a strong argument that with this business, you get what you pay for.

The FTSE 100 has risen by less than 20% over the last 20 years. But the Diageo share price has risen by 345% since December 1998. During the same period, the group’s dividend has risen by 180%.

Should you keep buying Diageo today?

It’s clear to me that if you can spot long-term quality growth stocks like Diageo and hold them for long periods, you can beat the market by a big margin. Outsized gains like this could easily help you retire early.

I can’t say if the rate of growth over the last 20 years will be maintained. But I can say that, in my opinion, Diageo’s financial performance looks very promising.

Last year, the group generated an operating profit margin of 30% and a return on capital employed of 15.8%. Earnings of 118.6p per share were backed by free cash flow of about 100p per share. This demonstrates the group’s excellent cash generation, which supported the dividend (65.3p per share) and provided cash for new growth projects.

Broker forecasts for 2018/19 put the stock on a forecast P/E of 22, with a dividend yield of 2.5%. That may not seem cheap, but for long-term investors I think it could be a good entry point.

A quality bargain?

If you’re looking for quality stocks at bargain prices, you may need to consider smaller companies, or businesses facing temporary problems.

One possible choice is Photo-Me International (LSE: PHTM), which operates 47,000 self-service photo-ID booths, printing kiosks and laundrettes in 18 countries, including the UK.

Photo-Me’s share price fell by 10% on Monday morning after the firm warned that meeting full-year forecasts would require “normalised trading conditions in its key markets.” This comment appears to relate to the UK market, where “large order lags” for new machines have been reported. The company does expect a recovery during the second half of the year, but this isn’t certain.

The 8.5% yield could be safe

Although the firm’s pre-tax profit fell by 21% to £26m during the first half of the year, today’s figures show that the group’s operations generated an operating profit margin of 17% and a return on capital employed of 20.6%.

These are impressive figures, especially as the group’s half-year operating profit of £25.7m was backed by free cash flow of £23.6m, before acquisitions. Such strong cash generation helped to maintain a net cash position of £32.4m, despite £28.8m of dividend payments over the last 12 months.

After today’s fall, Photo-Me shares trade on a forecast P/E of 10.2 with a dividend yield of 8.5%. The group’s management still needs to show it can return the business to growth. But at this level, I think this could be an opportunity for income-seeking investors.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.