Brand Value and the Case for Diageo (NYSE: DEO)

I realized today that in my previous posts I talk mostly about the fundamentals of a company. I spend a lot of time on ratio analysis, discounted cash flow analysis, any method based on the principles of accounting. This constitutes 70% of my investing decision, and as such, I will not look at a company if it's books aren't suitable.

This being said, I do have other criteria. The other 30% deals with more qualitative factors. This includes assessing the economics of the industry the company is in, market sentiment, and brand value. While good marketing departments emphasize sales goals, great ones emphasize brand value. I think we all have a pretty good understanding of brands: they are the sum total of all the images, sounds, feelings, and perceptions thrown at you by marketers. This component is important, 30% of my decision important. For something this important, I'm not comfortable keeping this analysis qualitative.

Interbrand - 100 Best Global Brands of 2010

When I looked through this list it was pretty consistent with what a list of the top 100 corporations by market capitalization would look like. In certain cases however, there are powerful brands that are either owned by private companies, or are just one division in a holding company or conglomerate. Mercedes-Benz and Zara are two examples.

Who has heard of Diageo (NYSE: DEO)? If you haven't, let me give you a little tour:

Included above is the world's best selling whiskey, tequila, liquer, stout, and vodka. Three of the above are also feature in Interbrand's list of the top 100 brands. Brand value gives companies ease when looking to break into new markets, raise prices, and increase revenue in general. With this list of respected labels, investors would be fools to not at least give Diageo a look.

Fundamentals


Okay, now to the important stuff, the 70%.

I found external research that did a discounted cash flow analysis on Diageo that gave a fair value per share of $138. When looking at their numbers I consider it to be a bit liberal, but still, $138 (when it's trading at $73) is a huge margin of safety.

Price/Sales of 2.99 and PEG of 1.49 are below the industry average and very reasonable. With a net profit margin of 18% it is also the 4th most profitable in the industry. This being said, it's not a particularly fast growing company with an average of close to 8% EPS growth over the past 5 years.

It has only 16% institutional ownership which is a plus from the Peter Lynch perspective. It means the 'smart money' is ignoring it and could push it higher in the future. It's only got 3 analysts covering it which means current earnings estimates are more likely to be inaccurate and leaves room for surprise. However, the 3 analysts collectively have a target price of $85, meaning the consensus is still positive.

With a two year time horizon I am extremely confident a valuation of $95 is realistic and ideal for the more conservative investor. For those willing to wait and weather potential resistance at this level, I have a target of $108.

Disclosure: I own no shares in Diageo (NYSE: DEO) 

Gold: Will You Bet Against Buffett?

"Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head." - Warren Buffett

Commodities do not innovate; they are not ideas and the only way they increase their value is either by becoming scarce (supply) or becoming popular/more useful (demand). The reason equities, historically, are the best asset class is because companies have to adapt to their environment; they are forced to improve. Gold will never change. Google (GOOG) may be around in 50 years time, and I have no idea what it will be doing. Gold will also be around, but it won't be doing anything. 

"If you are not willing to own a stock for 10 years, do not even think about owning it for 10 minutes" - Warren Buffett 

Are we unjustified in replacing 'a stock' with gold? I'm not arguing the possibility that gold has far to run, it may, but why bet on it? 

Gold's long term average is between $700-$800/oz. As I write this it's at $1369/oz (CAD). 

In this article, HSBC fund manager Charles Morris says, "I absolutely believe it's heading into a bubble, but that's why you buy it...a bubble is good." Legendary investor George Soros agrees and has put considerable money where his mouth is. Their investment thesis: it's going up regardless, might as well hop on board. It's not a thesis, and it's not investing, it's speculating. 

A friend of mine said to me recently, "gold just keeps going up eh?" I didn't know how to respond. He then asked, "you think it'll keep going?" Again, I didn't know how to respond. My friend has no investment training, knowledge, and usually has very limited interest in the markets. If he is talking about gold, maybe it's a sign we are talking too much. 

Buying gold takes faith, and I have greater faith in the wisdom of Warren Buffett.

Bullish on China Mobile (CHL)

Disclaimers are usually put at the end of an article but I'm just going to go ahead and say it...

I Own Shares in China Mobile

Why am I a huge bull on this company? Is there one thing I know that the market doesn't?
No.

The reason I'm so confident is because of the overwhelming number of reasons to own these shares. Mainly:

1. Amazing Valuation
2. It's in China
3. Check the chart


Valuation
P/Earnings= 12.2 (five year average = 17.5)
P/Book= 2.6
P/Free Cash Flow= 6.3

That's cheap for a $212 billion company with

Profit margin: 25%
Debt/Equity: 2%
Cash: $11.6/share
ROE: 23% this year

China
It's in China! That means I don't have to participate in QE2 debate, I don't have to pay attention to foreclosures, I don't care about the republican party. Regardless of your opinions on China's future, at present it is the most competitive country in the world. I'm not an advocate of only investing in China (nor am I a bear on the US) but now is the appropriate time to think about global diversification. The reality is that some countries are now positioned to outperform in the next 10 to 20 years, and by the numbers, one of those countries is definitely China.

Chart

I look at a chart at the beginning of my analysis and at the end. The majority of the research should be based on the books; the quantitative scorecard of any business. But right here we can visually see the upside potential. Before the crash it wasn't volatile, it just consistently surged upward. It also looks like it's resumed that trend in the past year. We are effectively getting a 50% discount IF we believe that the underlying fundamentals of the business have not changed.

They haven't changed.

We would have heard about 'disappointing figures' or a 'bleak future' from analysts. Or we would recognize superior value in a smaller competitor threatening to take market share. So far neither of these have happened. Even if China Mobile has squeezed all the potential out of its market, it's still the market leader, it still provides a necessary and valuable services and products; is it really justified to cut it's value in half?

I have a price target of $80, but considering they have a 3.5% dividend yield, I'm happy to hold.


Disclaimer: The analysis made is not to encourage speculation or investment in the companies mentioned. I am currently long shares of China Mobile (CHL).