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Wealth Accumulated

Wealth Accumulated

By D J Thomas, a large-cap stock market value investor and financial writer

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Balance sheet

Diageo: the world’s greatest boozer

January 31, 2023 by D J Thomas

Diageo and it's suite of branded premium drinks
If you like boozing premium brands, Diageo’s your best friend

Wealth Accumulated is long Diageo (LSE: DGE) after an extremely positive half-year report from the firm.

Diageo is a London-listed owner of over 200 premium drinks brands that sell to over 180 countries.

Jonnie Walker, Guinness, Baileys, Smirnoff, Captain Morgan, and a suite of Scotch Whiskey Diageo brands itself as the world’s foremost premium drinks brand builder.

Let’s take a look at the latest numbers:

  • net sales of £9.4 billion, up 18.4%
  • organic net sales grew 9.4%, with growth in all regions
  • operating profit of £3.2 billion, up by 15.2%
  • basic earnings per share of 100.9 pence, up by 19.7%
  • Free cash flow of £817 million, down by 48%

Free cash flow tanked, here’s what the firm offered as a reason for the fall in FCF (emphasis mine):

… a higher year-on-year working capital outflow, higher cash tax and interest paid, and increased capital investment. The higher year-on-year working capital outflow was due to the normalisation of creditors relative to the first half of fiscal 22, as our growth rate began to moderate in the first half of fiscal 23…

Diageo half-year report, 26th January 2023

In other words, as sales began to slow interest payments became more expensive.

More cheerfully, growth in revenues and operating profits were attributed to ‘premiumisation’ – consumers turned to premium drinks brands despite the high cost of living to treat themselves, even though they cut spending in other areas of their lives.

Diageo also noted that ‘price increases and supply productivity savings more than offset the impact of absolute cost inflation on gross margin.’

Scotch, tequila, and beer accounted for the most favoured drinks from consumers and the most growth in sales.

All-in, a good set of numbers for a global brand navigating the fall-out of covid.

The Diageo balance sheet

Specifically the debt.

In the highly upbeat report, there was little mention of the debt by management so it pays to dig a little deeper into how strong the balance sheet actually is.

Diageo has always carried a lot of debt relative to its equity but the firm touted a ‘strong balance sheet’ on the basis that its leverage ratio (adjusted net borrowing to adjusted EBITDA) is 2.5x as of 31 December 2022, the lower end of its target range.

It was able to remain within the lower end of its target range by adding back increased finance charges, an exceptional intangible impairment, and an exceptional operating item to the calculation of EBITDA.

This had the effect of masking the increased indebtedness Diageo had undertaken in the period.

This financial manipulation is not new and attempts to curve fit a firm’s financial strength into the false safety of a ratio that does little except to hoodwink investors.

A much better look at Diageo’s financial strength is as follows for the six months to 31st December 2022:

  • Market cap: £76.88 billion
  • Net debt: £15.16 billion
  • Revenue: £9.4 billion
  • Pre-tax profit: £3 billion

No doubt there are disposals in the pipeline for Diageo as it seeks to strengthen it’s brand offering by acquiring premium brands around the world which could be used to pay down debt.

But from a cash flow and financial strength perspective, I wouldn’t like to see net debt go much higher than it is already since its assets (and liabilities) held for sale, including Guinness Cameroon S.A., amount to only £106 million.

Can Diageo handle the debt?

CEO Ivan Menezes was confident about Diageo’s future prospects:

As we look to the second half of fiscal 23, whilst the operating environment remains challenging, I remain confident in the resilience of our business and our ability to navigate volatility. We believe we are well-positioned to deliver our medium-term guidance of consistent organic net sales growth in the range of 5% to 7% and sustainable organic operating profit growth in the range of 6% to 9% for fiscal 23 to fiscal 25.

Ivan Menezes, CEO, Diageo

These growth targets are already being met and the challenge for Diageo is to continue to meet them for the rest of 2023 and beyond. A target they have set themselves.

From a section entitled ‘fiscal 2023 outlook’:

In North America, organic net sales grew 3% in the first half of fiscal 23. We expect organic net sales growth to continue to normalise through the second half of fiscal 23, compared to the double-digit growth in the prior period. In Europe, we expect organic net sales growth to moderate in the second half of fiscal 23 as we lap on-trade re-opening recovery. In Asia Pacific, Latin America and Caribbean and Africa, we expect continued growth through the second half of fiscal 23, albeit at a moderated pace relative to the strong growth in fiscal 22.

So slower growth, but growth is forecast nonetheless and it’s fair to say that the strength of their brands and the continued investments in ad spend and premium brand acquisitions should help them achieve their targets.

Why I didn’t buy this stock when it was £25 – £30 a share is beyond me, but I’m in at an elevated price so Diageo represents a smaller percentage of the overall portfolio for now.

Is it time to go all-in now that inflation is easing?

January 14, 2023 by D J Thomas

Egg prices exploded 60% higher last year

Traders: ‘I’m going all-in to the market now that CPI (inflation) is declining. But no. We’re still fearful.

Banks: ‘Nope. A recession is coming. A mild one. But a recession nonetheless. Plus we’ve raised our credit loss provision substantially… because… well… the economy is screwed for 2023′

The Fed’s inflation fight

People like Jim Quinn are shelling out upwards of $6 and $7 for a dozen eggs. Quinn has run daytime eatery The Hungry Monkey Café in Newport, Rhode Island, with his wife, Kate, since 2009. As a breakfast and lunch joint, it leans heavily on eggs for the majority of dishes on its menu — and especially for the 15-egg King Kong omelet novelty food challenge at the restaurant. The cost of food is still hard to swallow, but the latest Consumer Price Index shows that those price increases — by and large — are at least growing at slower rates.

We’ve seen a decline in some measures of inflation but we have a lot more work to do, so I expect the [Federal Open Market Committee] will continue raising interest rates to tighten monetary policy

Michelle Bowman, Federal Reserve Governor

Bowman continues: “I expect that once we achieve a sufficiently restrictive federal funds rate, it will need to remain at that level for some time in order to restore price stability, which will in turn help to create conditions that support a sustainably strong labor market”

The business of banking

Recent fourth quarter results from the large-cap banks:

  • Goldman Sachs: earnings of $3.32 per share vs. $5.48 estimate
  • JP Morgan: earnings of $3.57 per share vs. $3.07 estimate
  • Citigroup: earnings of $1.10 a share vs. $1.14 estimate
  • Bank of America: earnings of 85 cents per share vs. 77 estimate
  • Morgan Stanley: earnings of $1.26 per share vs. $1.19
  • Wells Fargo: Earnings: 67 cents a share vs 66 estimate

Credit losses and wage inflation are to blame for Goldman Sachs’ hit to earnings. Here’s a free business tip if you run a bank: do not offer excessive salaries to ‘recruit and maintain talent’, shareholders will not be happy. Citigroup have the lowest PE ratio from this group at 7.07 at the time of publication.

Once a long term loser, always a long term loser

We need to talk about long-term FTSE 100 losers. Just one actually. Ocado (LSE: OCDO).

And to do that we need to take a quick look at the numbers.

*Checks numbers*.

Oh dear.

Is it me or is the only positive aspect of the Ocado business the balance sheet? Speaking of which:

Following our recent successful financing, we now have a strong financial position and ample liquidity to fund the requirements of our existing and expected customer commitments into the mid-term. No additional Group financing will be needed as the business becomes cash flow positive

Tim Steiner, Chief Executive Officer of Ocado Group

Unfortunatly, Steiner uses cash flow v free cash flow because free cash flow has been non-existent at Ocado, oh, for its entire operating history except for 2018. Also cashflow has been positive in the past yet for most of its operating history, Ocado has posted losses.

Ocado isn’t even on my watchlist.

The most profitable stock market investing strategy of all time

October 9, 2022 by D J Thomas

Profitable stock market investing

I’ve talked for years about how Benjamin Graham, the father of value investing, taught the public a profitable stock market investing strategy without relying on Wall Street or The City to do it for you.

One advantage of a DIY approach to stock market investing is that you will cut out the fees professional money managers will charge you.

They will often charge you fees even when they lose you money in bear markets or they are simply unable to beat the S&P 500, which most of them cannot.

You can simply buy a low-cost S&P 500 index fund in your broker account and make more money over the long term than the vast majority of professional money managers.

But you’re here because you’d like to understand how a more sophisticated approach to making money from the stock market can yield even better results over a long-term time frame.

The Relatively Unpopular Large Company

The Relatively Unpopular Large Company is the name Benjamin Graham gave to a value investing strategy that is simple to understand so that you can start using it once you get to grips with it.

Graham described the strategy as ‘conservative and promising’:

The key requirement here is that the enterprising investor concentrate on the large companies that are going through a period of unpopularity

Benjamin Graham, The Intelligent Investor

The key skill you’ll need to develop is determining that the period of unpopularity is temporary.

But more on that later.

Let’s break down how this strategy works.

Concentrate on large-cap stocks for profitable stock market investing

Concentration on the largest of stock market listed companies ensures that over time, you’ll develop an intuition, a sixth sense within the large-cap space.

Familiarity does not breed contempt in this situation.

Trying to invest in stocks of all shapes and sizes can be done, but we are here to develop a niche skillset in the ‘safest’ part of the market.

For one thing, large caps are the most talked about, followed, analysed, and written about stocks in the world.

This means that your research process on individual stocks going through a period of unpopularity begins with a simple Google search.

More importantly, large-cap stocks and the businesses behind them employ the brightest minds in the world.

That intellectual capital is what Ben Graham was relying on when he said of this strategy:

The large companies thus have a double advtange over the others. First, they have the resources and capital in brain power to carry them through adversity and back to a satisfactory earnings base. Second, the market is likely to respond with reasonable speed to any improvement shown.

Benjamin Graham, The Intelligent Investor

Look for stocks with a market capitalisation of at least $10 billion, many of them being household names familiar to you.

Yahoo Finance, Google Finance, and many other free services will give you this information.

If you’re a European investor then indexes like the FTSE 100 in the UK, the CAC 40 in France or the DAX in Germany offer convenient lists of large caps to research from.

Determine if the period of unpopularity is temporary

Guesswork will not do for this or any aspect of the strategy.

You will need to do some research if all of a sudden your news-feed flashes the headline ‘XYZ large-cap stock has collapsed in price today’.

Here is a starter list of questions you’ll need to answer to help you determine the timeline of unpopularity:

  • Why did it collapse in price?
  • How short-lived is the issue that caused the price collapse?
  • Does it have a strong balance sheet?
  • Has it hit 52-week or multi-year lows?
  • Is the general market in a bull or a bear market?
  • What is the long-term (10+ years) dividend record?
  • How likely will the company ‘turn itself around’ based on what management v what The Street says?
  • What is the PE ratio average over the past ten years (PE10) compared to the PE ratio over the last twelve months?
  • Has the long-term return on capital employed (ROCE) been historically high? (at least double digits).

Some of these questions are abstract and will have no definitive answer.

Some of these concepts like PE10 or ROCE will be new to you and are based on mathematics.

In both situations, the research process is about building a picture of the long-term success or otherwise of a business, where it sits in the current business environment, and how well based upon your research you think the business will turn itself around after a setback.

Learning about PE10, ROCE and other useful financial ratios is part of the process of becoming a better, intelligent, and enterprising investor.

It is the difference between dollar cost averaging with a low-cost S&P 500 tracker (set and forget) or seeking a higher reward for more work.

Sometimes you will not have a clear yes or no answer as to whether the unpopularity of a company will be temporary.

In this scenario, you should simply place the stock on a watchlist and monitor the news flow about the stock.

You would have already done the hard work of researching it, so it’s best not to waste that work.

Keep it on your radar, monitor news about it, and gain a better understanding of the business to determine when it’s time to buy.

Is investing in large-cap stocks a good fit for your mindset?

At the start of this article, I stated that the relatively unpopular large company strategy was the most profitable of all time.

Warren Buffett uses something close to this strategy, with a focus on large businesses that have shown consistent growth and a historically high return on capital employed (ROCE).

Buffett also buys businesses outright and has a vast pool of cash to play with, and combined with his reputation, he creates deals that we cannot.

That said, he is the wealthiest most successful stock market investor of all time and his investing mentor happened to be Benjamin Graham, the inventor of this strategy and the father of value investing.

But before you stride out there on your lonesome, a word of caution.

There are hundreds of articles, white papers, and books written about the best stock market investing strategies in the world.

What the vast majority of them lack is what I call a ‘mindset fit’.

This mindset fit is the distance between a stock market strategy and the way you think as an individual.

If you think you need charts, indicators, and a constant refresh of your broker’s app for stock market prices every 15 minutes then this strategy of relatively unpopular large companies is not for you.

You’ll likely need a short-term trading strategy based on technical analysis.

If you value your time to enjoy what the world offers without having to look at charts and stock prices all day then the relatively unpopular large company is for you.

Most of your time will be spent keeping abreast of financial market news rather than staring at charts and prices.

Value investing is by its very nature long-term orientated so when you actually purchase stock in a large cap undergoing a temporary period of unpopularity, the price may not rise straight away and may even go lower before going higher.

This is exceptionally difficult for most people to accept which is why they feel the need to check stock prices constantly.

Checking the news is a much better use of your time since large caps tend to pay dividends whilst they sort themselves out.

Subscribe to the newsletter so that you’ll not miss another article on large-cap stock market investing and follow along with my own portfolio news and performance because I use this very strategy to make money from large-cap stocks.

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Recent Posts

  • Warren Buffett is holding a boatload of cash
  • The FTSE 100 hits 8000
  • Why Adidas is a relatively unpopular large company
  • How earnings from oil smash records whilst tech disappoints
  • Diageo: the world’s greatest boozer

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