In the early 90s, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) reported that it had built a position in the British brewing giant Guinness. The position was relatively small by today's standards. The group acquired 31.2 million shares in Guinness, worth around $302 million. However, this was a significant investment for the group at the time, being its first major venture into a foreign market.
The investment was not a roaring success for the Oracle of Omaha. It is believed Berkshire paid around 644 pence ($8.90) per share for the holding (on the London Stock Exchange, shares are listed in pence rather than pounds). A decade later, the stock was changing hands for around 700p. It is unclear when Warren Buffett (Trades, Portfolio) decided to sell the holding, as the transaction was not disclosed to the market.
A lack of growth
In an early letter to investors, Buffett explained why he bought the position:
"Our Guinness holding represents Berkshire's first significant investment in a company domiciled outside the United States. Guinness, however, earns its money in much the same fashion as Coca-Cola and Gillette, US-based companies that garner most of their profits from international operations. Indeed, in the sense of where they earn their profits β continent-by-continent β Coca-Cola and Guinness display strong similarities".
Today the company is known as Diageo (DEO, Financial) (LSE:DGE, Financial). In 1997, Guinness and Grand Metropolitan merged to form the new group, which is one of the largest alcoholic beverage groups in the world today.
The stock's performance has perked up during the past decade. It has produced a total annualized return of 11% since 2011.
Looking back at the Oracle's comments on the position, it seems as if he made a strategic error here. At the 1994 annual meeting of Berkshire investors, Buffett outlined his investment case for the stock and concentrated on the brewing side of Guinness, rather than the distilling side, which produced and still produces Scotch.
He said:
"Guinness makes a lot of money in the business. But, I would not β I don't see anything in the β in published history that would lead you to believe that the growth prospects, in terms of physical volume, are high for scotch."
He went on to add that while he thought the company was a great business, without growth at the distilling division, the enterprise may struggle to develop:
"But, they will have to do well in distilling or β I mean that will govern the outcome of Guinness. I think Guinness is well run and it's a very important company in that business. But, I wouldn't count on a lot of physical growth."
Diageo has been able to outperform this downbeat projection by investing in and expanding its premium spirits sales. Thanks to the general expansion of the luxury goods industry over the past decade or so, these efforts have yielded results.
Sales have grown at a compound annual growth rate of 4% per annum, and profits have increased at a compound annual growth rate at around 5% as the group's operating margin has risen from 28% to 33% of 2019.
Buffett's analysis of the business was correct in the respect that a company with a strong brand and modest growth prospects will achieve impressive results for investors in the long run. Today Diageo has a selection of billion-dollar brands and a leading position in several of its major markets. It is a much stronger business today than it was in 1991.
Even though some consumers may be drinking less, the international spirits market is growing, especially at the luxury end. Diageo could be one way to invest in this trend as a long-term buy-and-forget investment considering its brand strength and diversified portfolio.
