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Can Diageo's share price keep pushing higher?

Diageo’s [DGE] share price, which as of Monday was trading around 3420p, has continually trended upwards so far this year. Since January 28, the British alcohol company has added roughly 719p, or 26.6%, to its share price.

The uptick has continued into the summer, with shares up 0.33% over the week commencing 10 June. In addition, the drinks firm’s stock is up 26.2% from its 52-week low. 

With a market cap of £80.51bn and a healthy P/E ratio of 28.50 (TTM), Diageo’s immediate prospects look strong, especially in the run up to reporting its fiscal year end results on 30 June. And yet investors, appear sheepish.

 

Investors held by the anchoring effect 

Despite Diageo’s share price being up a massive 22.52% year-to-date, the stock currently has an average hold recommendation among City analysts, with nine holds, six buys and one sell recommendations, according to Reuters.Diageo 1-year share price performance, CMC Markets, 18 June 2019

 

The skepticism surrounding the stock could be due to long-term concerns surrounding the longevity of the alcohol industry, as the shift towards the alternative drinks market continues to be fueled by the health and wellbeing trend.   

Or there could be a more abstract explanation: investors have become snagged in what psychologists refer to as the anchoring phenomenon. Anchoring refers to when investors begin to avoid bidding on high performing shares because – based on irrelevant financial information – they assume higher risks.

High-performing stocks like Diageo that are at or near the peak of their 52-week or all-time high can often fall victim to cautious investor sentiment such as this, and decelerate as a direct result. How this often works is investors keep a company’s 52-week high figure set in their mind as an ‘anchoring’ figure that cannot be exceeded, and therefore doubt the stock’s potential to rise higher. 

Jack Brumby, a contributor at Investopedia, writes of anchoring: “As humans, we tend to take our time when it comes to changing our opinions in the face of new information – even when it's good news.

“As humans, we tend to take our time when it comes to changing our opinions in the face of new information – even when it's good news” - Jack Brumby, a contributor at Investopedia

“This emotional tug-of-war often ends with the ‘new high’ stock drifting higher in price over the coming weeks and months. The upward trend is called ‘post-earnings announcement drift’. As the news sinks in, momentum takes over and the price moves higher.

“With Diageo trading close to its 52-week high, it’s possible that investors in the market are uncertain about whether to buy, hold or sell it. This uncertainty can cause erratic pricing in the short-term before momentum takes over – and it’s worth considering this before making your own trading decision.”

 

What about cash flow problems?

Another reason why investors are taking a cautious stance on the stock could be because of Diageo’s low cash flow yield. Indeed, the company has a relatively strong top line that’s allowed it to generously reward shareholders in the past. Its dividend has risen 35% over the past five years while its forward-looking dividend yield for the current trading year to June 2019 sits at 2% – above the 1.75% industry average.

 

Market cap£81.11bn
PE ratio (TTM)28.69
EPS (TTM)119.30
Return on equity (TTM)27.02%

Diageo share price vitals, Yahoo finance, 18 June 2019

 

But despite being known for its consistent cash inflows, Diageo’s operating cash flow yield of 3.1% (TTM) “indicates its sub-standard capacity to generate cash, compared to the stock market index as a whole, accounting for the size differential,” according to Simply Wall Street.

“This means investors are taking on more concentrated risk on Diageo but are not being adequately rewarded for doing so.

“Although its positive operating cash flow, and high future growth, is appealing, the low free cash flow yield is unattractive. This is because you would be better compensated in terms of cash yield, by investing in the market index, as well as take on lower diversification risk.”

 

Are gun-shy investors right about slowing momentum?

Diageo’s share price hasn’t exactly had consecutive month-on-month increases since the start of 2019. In March, the company’s share price rose 6.8%, while in the subsequent month it rose just 4.2%.

4.2%

Diageo's share price gain in April

When looking at Diageo’s competitors, it’s share price performance is marginally better. During the same time span as when the company’s share price began its current upward trend from late January – in which it rose 7.8% between 28 January and 28 February – competitor Pernod Ricard added 7.4%. What’s more, Diageo shareholders are getting a decent return for their pound at 119.30p per share (TTM), which is around a 13% uptick year-on-year.

Kevin Godbold, market analyst writing in Motley Fool, said of the drinks firm’s stock: “The outlook is positive and City analysts following the firm expect earnings to grow by high single-digit percentages this trading year and next. I’d be keen to make the stock a core holding in my portfolio and would look for weakness in the stock market as an opportunity to pounce on the shares.”

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