Beer Dividends From Diageo

In 2007, Diageo debuted its publicly traded ADR with the ticker symbol DEO for investors in the United States. An ADR means a sponsoring bank–in the case of Diageo, it is the Bank of New York Mellon–goes over on the London Stock Exchange and purchases a giant block of Diageo stock that is then packaged and sold to American investors. An ADR means the shares are created through a bank buying the shares on a foreign exchange and then supervising the trading; an ADS means that the corporation itself acts as an issuer of shares on a trading exchange outside of the country where the business is domiciled.

When the Bank of New York Mellon made Diageo shares easily available to American investors, the stock traded at $74.50 per share. At the time, the alcohol corporation was making $4.02 per share in profits and paying $2.63 of those profits to shareholders as dividends. That gave you a starting valuation of 18.5x earnings and a starting dividend yield of 3.53%. Given that 2007 was a year in which many stocks were trading a bit on the moderately valued side, the initial American availability of Diageo was a pretty darn fair deal.

The dividend payments, without any reinvestment, have played out as follows: you got $2.63 in 2007 dividends, $2.73 in 2008 dividends, $2.37 in 2009 dividends, $2.28 in 2010 dividends, $2.60 in 2011 dividends, $2.77 in 2012 dividends, $2.99 in 2013 dividends, $3.37 in 2014 dividends, $3.46 in 2015 dividends, and an estimated $3.60 in 2016 dividends.

That is something to get excited about considering the money came from one of the highest-quality corporations in the world. The risk that was necessary to achieve that income was about as low as you can find in the public markets (out of 15,000 publicly traded corporations, it would be difficult to name more than a few dozen that pose a lower long-term risk of capital impairment to shareholders).

Over its first decade of easy availability for American investors,, Diageo ADR holders will collect an estimated $28.80 in dividend income. That’s a 38.65% return of cash from your initial investment because of the Diageo Board’s decision to regularly distribute some of the corporation’s profits to its owners. If you invested $10,000 in Diageo when it became available in 2007, you would have collected $3,865 in cash dividend payouts over that time frame if you did not reinvest any of your dividends.

If you did choose to reinvest, the amount of income you would have collected over this time would have been $4,383. You would have reinvested at an average share price of $92.41 along the way (this is assuming that the 2016 dividend prediction of $3.60 holds accurate and those 2016 dividends get reinvested at an average market price of $107.) Someone that purchased 134 shares at the time of the Mellon Bank offering would have picked up an additional 47.4 shares due to a decade of reinvestment.

Those 47.4 shares now have a market value of $107 each, or $5,071 in total.

The true economic value of these things would be arduous to calculate precisely, as you would need to adjust each dividend payment for inflation through 2016, plus you would need to acknowledge the increased purchasing power of someone who received a dividend in 2009 and chose to spend it on goods then rather than using our 2016 understanding of that dividend check’s value to extrapolate that back to the purchasing power seven years ago, and you would also have to recognize that the first figure which doesn’t include dividend reinvestment is somewhat understated because it assumes stagnant capital (i.e. it assumes that you let the dividends in 2007, 2008, 2009, and so on hit your account and then just sits there without being put to productive use).

Those caveats aside, we can still get a pretty good approximation of what you can do in ten years when you own an exceptional high-quality asset that pays out a dividend that mirrors around 3% of its stock price each year and then watch the share count climb upward. Usually, the income investor’s focus is on the increased share count and the higher future dividend payments that result from that higher share count. But an additional bonus is that each of those reinvested dividends gets in turned into additional shares that subsequently rise in market value as the intrinsic value of the corporation increases over time.

The advantage of collecting $2.63 from Diageo in 2007 isn’t just that those 134 shares throw off $352.42 in cash that converts into 4.46 additional shares at an average reinvestment price of $79.02. And it’s not only that those 4.46 new shares will soon start paying out dividends of their own. The underanalyzed third benefit is that those 4.46 shares, which originally had an economic value that corresponded to a share price of $79.02, now have a value of $107. That 2007 reinvestment of $352.42 now has a market value of $477.22. And that doesn’t even include all of the dividends that got created by those additional 4.46 shares over the 2008-2016 time horizon, nor their subsequent market value.

Long-story short? For someone that chose to reinvest dividends on an initial $10,000 investment, they got to receive $4,383 in cash from reinvestment that now has a market value of $5,071.

You can think of it like this: Just passively collecting your dividends from Diageo would give you dividend income of $3,865, or 38.65% of your initial investment. Choosing to reinvest your dividends means that you would have a rising share count that would in turn generate more cash for you, giving you $4,383 in total income, or 43.83% of your initial investment. And because those dividends got baked into additional shares that have risen in market value, the current ability to sell those shares created through dividend reinvestment would you a payout of $5,071, or 50.71% of your initial investment amount.

This is what I mean when I say that buying high-quality corporations at a fair price, sitting back and reinvesting the dividends, and watching the cash pile up is highly underrated as an investment strategy. It helps that the valuation of the stock remained reasonable throughout the entirety of this reinvestment measuring period, only once or twice crossing the 20x earnings threshold. Usually, it stayed in a valuation range of 16x earnings to 19x earnings. The absence of overvaluation is quite helpful for those that are reinvesting their dividends as it lets you pick up more shares than would otherwise be the case.

For someone that reinvested for a decade on a $10,000 Diageo investment, you got $5,071 created through the reinvestment of dividends that rose in market value. You also had those 134 shares rise in value to $14,338. That’s $19,409 from 2007 through 2016 (though my calculations that I’ve used to this point include an expected 2016 dividend payout of $3.60 that hasn’t yet occurred). That’s not bad for a corporation that only saw its price rise from $74 to $107 over the measuring time frame. And in my opinion, those results are a bit understated because I contend that Diageo is selling a bit below its fair value right now.

Those 3% yielders with a core earnings engine around 8%–be it Johnson & Johnson, Coca-Cola, or Diageo–generate far more in dividend income than you might expect. Even though people are aware of the high quality of these corporations, they are often neglected because there is always something with a higher yield or some other corporation that seems to be offering a bigger discount to fair value. Depending on your skill set, those alternative investments may very well work out.

The advantage of the Johnson & Johnson, Coca-Cola, and Diageo long-term investing model is that you get to benefit from all three things: decent starting income, decent growth rate, decent rises in market value. With high yielders, what you gain in starting income is offset by a lower growth rate and lower increase in the market value of your holdings. With the fast growers, the growth rate may be higher, but the starting income is not. You have to make a trade-off somewhere, and yes, sometimes it’s worth it. But the advantage of fitting Johnson & Johnson, Coca-Cola, and Diageo onto your family’s balance sheet is that you are in the top third of publicly held securities for starting dividend amount, growth rate, and expected rise in market value of those reinvested dividends. The beer dividends from Diageo, when adjusted for dividend reinvestment, are far superior to what a casual glance at the history of Diageo’s stock price 2007-2016 would otherwise reveal.

Originally posted 2016-04-11 21:00:49.

Like this general content? Join The Conservative Income Investor on Patreon for discussion of specific stocks!