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This Overlooked Stock Can Thrive in Any Economy

Nobody likes a recession, but it happens, and one could be coming. The Federal Reserve is raising the federal funds rate to combat inflation and forecasting slowing economic growth and rising unemployment over the coming months.

Alcohol giant Diageo (NYSE: DEO) can be an excellent haven for investors looking for companies built to withstand tough times. Here is what makes Diageo such a durable business and what investors can expect from this overlooked giant moving forward.

A fully stocked bar

Diageo is a conglomerate, so consumers might not be familiar with the company. However, they likely know many of the 200 alcohol brands it owns, including Captain Morgan, Smirnoff, Johnnie Walker, Crown Royal, Guinness, Bailey's, and many others.

The company resides in London, England, another factor that makes it an overlooked gem among U.S. investors. Still it trades on the New York Stock Exchange as an American Depository Receipt (ADR), where banks buy shares on the foreign company's home exchange and sell certificates representing those shares to American investors.

Alcohol has been a part of cultures worldwide for thousands of years, and Diageo's roots trace back to the 1600s. Today, spirits are sold in stores and consumed in bars and restaurants everywhere. Diageo's revenue totaled more than 12 billion pound sterling ($15.6 billion) in its fiscal 2021.

Overflowing profits

Spirits are relatively simple products, consisting primarily of starches or grains, depending on the actual spirit. Diageo sells many premium brands, giving it a solid amount of pricing power. The company was hit hard during COVID-19 when social gathering venues were closed, but it is roaring back; revenue for the six months ended Dec. 31, 2021, grew 16% year over year to £8 billion.

Free cash flow was £1.6 billion for those six months, meaning that the business converted 20% of its revenue into cash profits for management to do as it wants.

That might mean acquiring up-and-coming brands to drive growth and preserve market share, like when it bought tequila maker 21Seeds earlier this year (for an undisclosed cash sum) or the share repurchases and dividends it funds each year.

DEO Dividend Yield data by YCharts

Investors can enjoy an almost 2.2% dividend yield, and the company's outstanding shares have fallen almost 10% over the past five years, helping grow earnings per share (EPS). A steadily growing, profitable business is one that investors can buy and hold for the long term and feel good about getting solid investment returns from without a ton of stress along the way.

Steady long-term growth ahead

Moreover, alcohol is a staple of society, whether people drink socially at bars and restaurants or buy spirits to drink at home. Diageo's leadership in such a timeless industry is arguably its most attractive feature to investors.

Diageo is one of the world's largest alcohol companies, yet the industry is so large and fragmented that it's poised to continue steadily growing for years. Management estimates it owns roughly 4% of the worldwide alcoholic beverage market, with a long-term goal to increase that 50% to a 6% share by 2030.

Analysts expect the company's 2022 EPS to come in at $7.20 and to grow by an average of 10% annually over the next three to five years. This matches the S&P 500's historical average growth rate, yet the stock trades at a premium to the index, commanding a price-to-earnings (P/E) ratio of 25 versus 20 for the S&P 500.

The stock has fallen nearly 20% from its high, and continued market volatility might push shares lower yet. However, the company could be seen by many as a defensive stock that might attract attention in a recession.

Investors who are on the fence about the numbers could always dollar-cost average to build a position slowly. Still, Diageo is poised to be around many years from now, making it a reliable investment if given enough time to do its thing.

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Justin Pope has no position in any of the stocks mentioned. The Motley Fool recommends Diageo. The Motley Fool has a disclosure policy.


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