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One of the toughest decisions any value investor faces is assessing the likely length of time a stock will remain out of favour with the market. After being in a steady decline for over two years, I’m now asking myself should I swing my bat and buy some Diageo (LSE: DGE) shares for my Stocks and Shares portfolio?
Consumer squeeze
In 2024, what really hurt the company’s share price was cash-strapped Latin American consumers downtrading to cheaper brands. On the face of it, this looked like a potentially localised, transitory issue. But this turned out to be anything but.
Far too many investors fret about headline numbers when it comes to inflation. That’s not the way to look at it though, in my opinion. Over time, consistently elevated levels of inflation alter consumer behaviour. Consumers don’t care about government-measured levels of inflation. Each person’s perception of inflation is based on their individual basket of goods and services.
This fact really matters to Diageo. What’s becoming abundantly clear to me is that brand loyalty matters less when disposable income’s in a downward trend.
Tariff wars
As consumer spending patterns have altered in the face of cost-of-living pressures, the prospect of a trade war could be disastrous for the business. Following President Trump’s decision to impose tariffs on Canadian and Mexican imports, in its H1 results released on 4 February, it announced it was removing forward guidance. This clearly spooked the market.
The immediate threat of tariffs has of course receded. This is unlikely to be of any comfort to investors though. In the US, (its biggest market) 45% of its sales are derived from products that must be produced in either Canada or Mexico.
What we do know is that last time the business had to navigate tariffs, it pushed through 100% of the resulting costs in additional pricing. Should tariffs come, I don’t envisage it will repeat such a move.
The business has for some time been undertaking detailed planning against such a contingency. Inventory management would certainly be a lever it would pull to ensure additional costs weren’t borne solely by consumers.
A falling knife?
Another way to think about a falling knife, is by means of a value trap. Identifying value traps are not that easy though. Many, including me, believed Rolls-Royce was one such trap in 2020, and lived to regret that decision.
At a fundamental level, what I’m looking to assess is whether an event or series of events has the potential to change the trajectory of an entire industry.
So what do I know? Well, outside of consumer psychology dynamics discussed above, I see evidence of an emerging trend around reduced alcohol consumption. This is particularly prevalent among Gen Z.
Of course, it’s far too early to draw any conclusions from such a narrative. My initial point of view is that this moderation trend plays in to the notion that people want to drink better, not more.
After being a runaway success for over 20 years, I expect Diageo’s share price to exhibit greater levels of volatility going forward. I don’t rule out an investment but will sit on the sidelines for now.
