Down 50% with a 4.5% yield and P/E of 14 – are Diageo shares a screaming Buy or a lethal value trap?

What to think of Diageo (LSE: DGE) shares? As someone who holds them, trust me, I’ve thought just about everything there is to think. But do I need to think again?

At first, I thought they were a bargain. The shares plunged 20% in November 2023 after the global drinks giant warned of falling sales in its Latin American & Caribbean division, as cash-strapped drinkers traded down from Diageo’s portfolio of premium brands to cheaper local spirits. I thought this was a brilliant opportunity to buy.

The shares fell further as other regions struggled too. Sales slowed, stocking issues lingered, profit warnings multiplied and US tariffs struck. Much-admired CEO Ivan Menezes died, and his successor Debra Crew struggled.

FTSE 100 conundrum

A wider debate raged. Had Gen Z lost the taste for booze, or simply the cash for it? Would weight-loss drugs like Wegovy and Ozempic curb humanity’s seemingly unquenchable thirst for alcohol? My emotions lurched from surprise to dismay to the odd attack of the trembles. But I never quite lost hope.

Diageo always felt like a premium stock to me. As the shares flew the price-to-earnings ratio nudged 25, while the yield hovered around 2%. So when the P/E slid to 20, then 19, then 18, it looked too cheap to ignore. Especially with the yield pushing towards 5%. So I bought a little more.

And when Diageo announced that my favourite turnaround specialist, Dave Lewis, would replace Crew from January, I bought a heap more. Didn’t ‘Drastic Dave’ transform a struggling Tesco? Surely he could repeat the trick at another ailing FTSE 100 heavyweight. If interest rates start to fall, might consumers feel a little better off and investors rediscover their appetite for risk?

Also, investing is cyclical, especially in consumer stocks. The Diageo share price is down 50% over three years. Surely it was due a change in fortunes?

Blue-chip recovery play

There are flickers of life. The stock’s up around 10% over the last month, though it’s slipped in recent days. Over 12 months, it’s still down 15%, so new investors haven’t exactly missed the boat. With the P/E the lowest I can remember at 14.4 and the yield pushing 4.5%, this could be the moment.

Unless my theory proves right – that spirits companies will end up like tobacco stocks, squeezing cash from a shrinking market. In that case, the P/E could fall further and the yield go higher. Then again, Big Tobacco hasn’t done too badly for patient shareholders.

We’re still waiting to see what Lewis will do. Asset disposals look likely. Diageo’s already planning to sell its east African brewery estate for $2.3bn and its stake in Shanghai-listed Sichuan Swellfun Co for $2.7bn. If they go through it should help reduce net debt, currently a hefty $22bn. There’s still a way to go though. My biggest fear? Lewis cuts the dividend to free up cash.

So far, Diageo has looked like a screaming buy and behaved like a deadly value trap. I remain optimistic that will change, and think the shares are well worth considering at today’s price. Investors will need strong nerves and patience to find out which it is.

Those are my thoughts today. But picking stocks is highly personal, and investors will have ideas of their own.