Diageo, Will It Benefit From The Lippy Effect?

Macroeconomic times change and as they do where we should be invested does too – this could prove an opportunity for Diageo PLC (LON: DGE) shares. The difficulty is in knowing exactly how those macroeconomic times are going to change.

The standard analysis says that capital hungry and adventurous tech firms will be less attractive when inflation rises and therefore so do interest rates. The price of investing now to gain later rises so therefore the current price falls. Exactly the same factors increase the value of firms producing now, profitable now, and paying dividends now – like Diageo. It’s a long time since anyone in the markets has had to face this situation, rising interest and inflation rates, but the old advice was indeed to move into fast-moving consumer goods (FMCG) with pricing power when that was the macroeconomic background.

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This may or may not be true right now but it is worth considering. At Diageo there is that dividend, nudging up to a 2% yield. The Diageo share price has fallen 10% since the start of the year so there’s a definite temptation to buy the dip. Of course, that’s also another way of describing trying to catch a falling knife but there’s risk in everything.

Alcohol consumption is falling, that’s true, but associated with that is that people are consuming better quality. For a company like Diageo which makes and retails premium brands, that’s a benefit. The higher margins on premiums can more than make up for lower overall spending.

There’s also something called “The Lippy Effect” which is derived, of all things, from female behaviour in recessions. This is that often enough lipstick sales actually go up as those of fashion, handbags and so on go down. The observation being that we all desire a little luxury, a little pampering, and if we can’t have it on big and major things then we’ll take a little bit of it by buying smaller yet premium items. It’s easy enough to see how this could happen with spirits. That luxury of better whisky for a few pounds more when the tens or hundreds of pounds to spend aren’t available. As long as things don’t get so bad we’re all back to bathtub gin of course.

It’s also true that Diageo sells all over the world, has revenues in many currencies, but reports in sterling. The UK is among the first to monetary tightening, pushing sterling up. But we do expect others to also raise interest rates in time and that boost to sterling to unwind. That’ll increase the pound value of those foreign profits in time.

In the short to medium term what matters for the Diageo share price is how much the market believes such stories will come true. In the longer how much they do rather than the beliefs. The problem for us as traders in Diageo is to determine both the likelihood of the story coming true and also of how many other people believe it will.