Monday, September 12, 2011

Diageo's Global Franchise

David Herro, Morningstar's International Stock Fund Manager of the Decade, in an interview said the following about Diageo (DEO):

"There is one nice, stable, well-managed company that at this stage does not appear very expensive, and it's a stock you could hold for a long, long time, unless it spikes way up. Again, you cannot forget price. That stock is Diageo..."

In the 1991 Berkshire Hathaway (BRKashareholder letter, Guinness was revealed as a holding for the first time.

These days, Guinness is one of the many leading global brands of Diageo.

Warren Buffett wrote the following in the 1991 Berkshire letter:

"Our Guinness holding represents Berkshire's first significant investment in a company domiciled outside the United States. Guinness, however, earns its money in much the same fashion as Coca-Cola and Gillette, U.S.-based companies that garner most of their profits from international operations. Indeed, in the sense of where they earn their profits - continent-by-continent - Coca- Cola and Guinness display strong similarities. (But you'll never get their drinks confused - and your Chairman remains unmovably in the Cherry Coke camp.) 

We continually search for large businesses with understandable, enduring and mouth-watering economics that are run by able and shareholder-oriented managements. This focus doesn't guarantee results: We both have to buy at a sensible price and get business performance from our companies that validates our assessment. But this investment approach - searching for the superstars - offers us our only chance for real success. Charlie and I are simply not smart enough, considering the large sums we work with, to get great results by adroitly buying and selling portions of far-from-great businesses. Nor do we think many others can achieve long-term investment success by flitting from flower to flower."

Diageo's strategic brands include Johnnie Walker, Smirnoff, Ketel One, Baileys, Captain Morgan, Jose Cuervo, Tanguerey, Guinness, Crown Royal, and J&B.

Diageo was first mentioned on this blog, as part of the six stock portfolio*, as a business with an attractive share price when it was selling at around $ 45/share. At that price it sported a dividend of around 5%. The current price is more like $ 76.

It's still a terrific franchise with intrinsic value that should grow nicely over time but the stock is a lot less interesting at current prices.

More from the 1991 letter:

"If my universe of business possibilities was limited, say, to private companies in Omaha, I would, first, try to assess the long- term economic characteristics of each business; second, assess the quality of the people in charge of running it; and, third, try to buy into a few of the best operations at a sensible price. I certainly would not wish to own an equal part of every business in town. Why, then, should Berkshire take a different tack when dealing with the larger universe of public companies? And since finding great businesses and outstanding managers is so difficult, why should we discard proven products? (I was tempted to say "the real thing.") Our motto is: 'If at first you do succeed, quit trying.'

John Maynard Keynes, whose brilliance as a practicing investor matched his brilliance in thought, wrote a letter to a business associate, F. C. Scott, on August 15, 1934 that says it all: 'As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one's risk by spreading too much between enterprises about which one knows little and has no reason for special confidence. . . .One's knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence.'" 

Diageo has many great qualities but, unlike Herro, I think it is not quite cheap enough to make incremental purchases (though I intend to continue owning it long-term unless valuation becomes extreme).

Recently, Diageo participated in the Barclays Back To School Consumer Conference.

Here's an article with some notes from that conference.

Adam

Long position in DEO and BRKb

*The six stock portfolio is up 67% compared to 37% for the S&P 500 over the same time period (including dividends for both the portfolio and the benchmark). There was no trading over that time frame. The portfolio is simply six good businesses bought at discounts to value with the intention of very long-term ownership. The economics of these businesses -- bought with a margin of safety to account for unknowables and misjudgments -- will generally drive returns over time...not trading skills. It's intentionally concentrated. Will rarely sell one of these if misjudged, something materially damages one of these franchises long run viability, price meaningfully exceeds estimated per share value, or if opportunity cost becomes very high.
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