The Diageo (LSE: DGE) share price has rebounded strongly since the stock market crash last year, hitting 3,600p recently. This has been due to a recovery in sales, a couple of shrewd acquisitions, and growing shareholder returns. With today’s promising trading update, which has caused the Diageo share price to rise another 2%, will it be able to reach 4,000p?
Strong recovery
Due to the closure of bars and restaurants, Diageo was certainly affected by the pandemic, and its profits during 2020 were 50% lower than in 2019. But in the year ending June 2021, the group reported an operating profit of £3.7bn, 75% higher than in fiscal year 2020. This demonstrates that the group has managed to mainly offset the impacts of the pandemic and is returning to full strength.
I also believe that the company is coming out of the pandemic in a better position. Indeed, it has made several acquisitions during this period, including buying Aviation American Gin and Loyal 9 Cocktails. It has also continued strong investment into its digital capabilities, consumer experiences, and sustainability. Accordingly, I feel that profits will be able to grow in the next few years and continue reaching record highs. This may help propel the Diageo share price to 4,000p.
Today’s trading update was also promising, with it reporting a “strong” start to the new fiscal year. This included an excellent performance in North America, and a quicker-than-expected recovery in Europe, caused by the reopening of bars and restaurants.
What could hold the Diageo share price back?
So far, the future looks extremely promising for the drink giant. But there are a few reasons why I think Diageo could have reached its peak, and will not be able to reach 4,000p. For example, the company currently face certain issues. These include rising inflationary pressures, which are partly due to supply chain constraints. This may increase the company’s expenses and strain profits.
Furthermore, Diageo already trades at a fairly lofty valuation. In fact, using its profits from last year, it has a price-to-earnings ratio of around 24. This is slightly over the average in the FTSE 100. If the Diageo share price reached 4,000p, with profits staying steady, it would have a P/E ratio of 35. This is extremely high, and as such, I feel profits would also have to increase for the Diageo share price to reach this milestone.
So, what am I doing?
As a current Diageo shareholder, I’m optimistic about the future. With bars and restaurants reopened, I feel that profits are likely to increase this year. In addition, the company’s large portfolio of drinks and global presence, will also hopefully offset the current short-term issues.
The company itself also seems optimistic, recently initiating a £1bn share buyback programme. This implies that it believes that the share price is not overly high and has space to rise. Provided that Covid cases can stay under control, I believe that Diageo will be able to reach 4,000p within the next year. As this implies a 10% upside, I may buy more shares.
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Stuart Blair owns shares in Diageo. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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