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Diageo (LSE: DGE) shares are in freefall, down 50% in just over three years. The drinksmaker’s dizzying fall has little to do with recent operations. Revenue is broadly at the same level as when the shares were twice the value. Earnings have climbed since then, too.
The bulk of the FTSE 100 firm’s share price fall can be attributed to a change in valuation. The price-to-earnings ratio, previously above 30, has fallen to around 15. Put simply, investors don’t see such a bright future for Diageo’s drinks as they once did and this has been sharply reflected in a much lower share price.
The burning question then is why? Why are investors fleeing en masse? What has given Diageo shareholders such a fright in the two short years since the stock was flying high?
Valuation issues
The main reason is that consumption is expected to decline in years ahead. The two primary causes driving this shift are young people drinking less and weight loss drugs reducing folks’ desire to drink. Diageo has its finger in one pie and one pie only – alcohol. So a gradual decrease of drinkers spells a terminal decline for the company and also its stock.
No matter how good the branding of Johnnie Walker, no matter what the market share of vodka Smirnoff has, no matter how many Tiktoks of celebrities trying to ‘split the G’ on a pint of Guinness go viral; if demand for alcohol drinks drops precipitiously, the falling share price of Diageo looks simply like a falling knife – not something you want to catch by buying the shares.
Tangle of thorns
The generational change in drinking habits is well documented, with Gen Z much maligned for this. A temporary blip? History suggests so. Wine is mentioned several times in the book of Genesis. It’s a bold prediction that humanity, after thousands of years together, is going to give up its relationship with the bottle.
On the other hand, previous generations didn’t have smartphones. Maybe an evening indoors doomscrolling Tiktok is preferable to a night out at the local boozer?
The second threat of weight loss drugs looms large too. As far as my understanding goes, drugs like Ozempic or Wegovy don’t jive well with alcohol. The buzz is worse, the hangover is worse, and some find the combination causes side effects too.
With 64% of Brits now either overweight or obese, that’s millions of slimmers who might be cutting down on alcohol in this country alone.
So where does that leave us? Diageo is a well-run company, trading cheaply, but with the rather large caveat that the entire industry might be heading for terminal decline.
I can’t help but compare the situation to the plight of British American Tobacco. Cigarettes were heading the way of the dodo back in the 1980s. Yet between 1984 and 2017, shares went up 20 times in value and with plenty of dividends to boot!
Predicting the future is not a particularly simple endeavour. All in all, I think there’s still enough here for me to hold onto my shares. However, I’ll be keeping an eye on them a lot more nervously than I was a couple of years ago.
