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)