Unconventional wisdom: Are investor expectations too low for these shares?
To be successful investors need to find situations where expectations don’t align with reality.
Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.
Unconventional wisdom: Are investor expectations too low for these shares?
Lt. Col. Frank Slade: Clear them little bottles off. And when I get off the phone here, call up Hyman and tell him I want it wall to wall with John Daniels.
Charlie Simms: Don’t you mean Jack Daniels?
Lt. Col. Frank Slade: He may be Jack to you son, but when you’ve known him as long as I have…
- Scent of a Woman
I’ve been thinking about liquor. Not in the way you think. But I do that too. I’ve been thinking about how people are drinking less and how spooked investors have sent alcohol related shares tumbling. Is this a sensible reaction to an emerging trend? Or is this an opportunity to pick up shares at a discount?
I’ve owned Diageo since 2008 and watched the shares drop over 30% in the last five years. The S&P 500 is up over 87% and the ASX 200 37% over the same period. That is significant underperformance but things could be worse – Endeavour is down 41%, Brown-Foreman 61% and Pernod Ricard 40%.
There are several reasons I’m intrigued by this potential opportunity. I am drawn to underperformance as a way of finding reasonably priced long-term winners. More importantly, these companies are aligned with the security selection criteria in my investment strategy.
I like the lack of cyclicality in the consumer defensive space. They pay dividends and have the higher predictability of future outcomes that come with lower uncertainty ratings. They all have sustainable competitive advantages as indicated by their wide moat ratings. They all have sound balance sheets.
To attempt to evaluate these companies I first need to understand what expectations are baked into the share prices. Next, I need to assess the validity of those expectations. If I don’t think investor expectations are realistic they represent an opportunity.
When you break down non-passive investing that is all it is – figuring out mismatches between expectations and likely outcomes.
The expectations game
When I first started investing I eagerly awaited earnings reports from companies in my portfolio. I would study the results and depending on the outcome either enthusiastically anticipate a bounce or steel myself against a pull back.
I would often be surprised when the market opened. Shares would plunge after seemingly strong earnings and a positive outlook. Mediocre or outwardly negative results would cause buyers to materialise. What I didn’t understand at the time was the irrelevance of absolute results. All that matters is how results compare to investor expectations.
Share prices reflect the collective expectations of investors. High expectations for the future result in high valuation levels. Low expectations equal low valuation levels. Outsized returns – on both the upside and downside – come when results meaningfully deviate from expectations. To profit as a fundamental driven investor means finding and exploiting mismatches between expectations and reality.
A cursory review of the price to earnings ratio for Diageo, Brown-Foreman, Pernod Richard and Endeavour show the impact of investor expectations dropping over the years. Context is important – during this time overall market valuation levels increased. All four companies went from trading at a premium to the overall market valuation to a discount. Something is clearly amiss.
My job is clear. To determine if these are attractive opportunities means assessing if the low expectations are warranted or simply an overreaction.
Some readers may view this as a challenging proposition. I agree - investing is hard. It may seem easier to simply jump on the momentum band wagon. Perhaps this means AI shares and their limitless future. Maybe piling into CBA.
Buying shot-term winners feels safe as it aligns with recency bias which is our tendency to assume that what recently has happened will continue into the future. Yet buying a share after a strong run is just playing the opposite end of the expectations game and sky high expectations are harder to exceed than low expectations.
Too many teetotalers
Gallup has been polling Americans on their drinking habits since 1939. According to a Gallup poll in August 2025 the number of Americans drinkers is at a 90-year low. Only 54% of US adults currently drink and most believe that even moderate drinking has negative health consequences.
The number of Americans drinking is dropping rapidly. Just two years ago 62% of Americans were drinking. Young Americans drink in lower percentages than middle-aged and older Americans which may indicate drinking rates will keep dropping.
Australians are also saying no more often to alcohol. According to a wastewater study published in The Drug and Alcohol Dependence Journal Australians are drinking 30% less volume of alcohol than seven years ago. Once again younger people are leading the charge with a Flinders University study showing Gen Z was 20 times more likely to avoid drinking compared to Baby Boomers.
Perhaps drinking rates will rebound but exploring what happens if they don’t is important. And there is some nuance beneath the headlines. It isn’t just about the number of people drinking but also what the remaining drinkers are consuming.
The key for companies like Diageo, Pernod Richard and Brown-Foreman is something known as ‘premiumization.’ This could be a pathway for the companies to continue to thrive even if less people continue to drink.
Drinking less, but better
An ideal situation for any company facing a shrinking market is for price increases to outpace declining sales volumes. There is some reason to believe this may be a viable pathway for companies in the liquor industry.
Examples of the impact of premiumization is found in data from the Distilled Spirits Council of the United States. Many consumers are trading up to spirits from beer with spirits making up 42.20% of total alcohol revenue versus 42% in beer. In 2000 spirits lagged beer by 27%.
Premiumization is not just about switching from beer to liquor. It is also about buying more expensive liquor. The secret accelerant to earnings is capturing higher margins when consumers trade-up. This happens when costs don’t rise to produce more expensive liquor at the same rate as prices.
Our analysts believe this thesis plays out. According to Morningstar sample data, a 15-year Chivas Regal bottle retails on average for a 60% premium to a 12-year Chivas Regal bottle. Here, we believe the difference in production costs between the two bottles would be minor for Pernod Ricard, leading to a material difference in margin.
This benefits companies that have large inventories of aging liquor. Something Diageo, Brown-Foreman and Pernod Richard all have. The need to age certain types of liquor also serves as a barrier to entry to new competitors.
Over the years we’ve seen brand extensions into more premium offering. Diageo’s Johnnie Walker scotch is an example. There used to be Johnnie Walker Red and Johnnie Walker Black. Now there is Green, Gold, Blue, Double Black and countless limited-edition offerings. Brown-Foreman has done the same thing with Jack Daniels releasing Gentleman Jack, Single Barrel, flavoured varieties and limited-edition releases.
A case study is the cigarette industry. Smoking levels have decreased for decades but steady price increases have allowed cigarette companies to continue to increase revenue. Will the liquor industry follow the same pattern? It is impossible to know for sure but there are at least some indications this is a viable outcome.
I believe investor expectations are too negative. This is not an ideal situation. It can be challenging to navigate a drop of overall demand. In situations like this pricing power is critical as price increases can overcome lower volumes. That is why I think brand is key.
For that reason, I’m going to slowly add to my position in Diageo and build a position in Brown-Foreman. Both companies have strong brands and I think they represent a better approach than a retailer like Endeavour. It is easier for me to buy direct shares in both than Pernod Richard which is listed in France.
Final thoughts
If you follow professional investors you constantly hear references to catalysts. A catalyst is an event that causes investors to rapidly reassess their view of an investment. This involves a change in investor expectations.
Despite the lip service that many professional investors pay to the merits of a long-term focus most are decidedly short-term orientated. This is a nod to a reality of investing – investors are fickle and short-term underperformance is punished. This is turn hurts the career prospect of most professional fund managers.
Given this context it is no surprise that professional investors seek out catalysts. It isn’t enough to be right – you need to be right quickly. Not facing these structural impediments provides individual investors with a substantial advantage. Unfortunately too many people give up this advantage and trade too frequently.
I don’t see an immediate catalyst to change investor’s negative view of these alcohol producers and purveyors. It won’t happen overnight. However, I do believe that investors will eventually realise their expectations are too low for these companies and I’m patient and willing to wait.
The hardest part of investing is managing our own expectations. We all want the immediate validation of rising prices right after we buy something. To time something perfectly is more a function of luck than superior insight.
As always, my investment approach is based on my own financial goals and investment strategy. The purpose of this article is not to follow my pathway but instead think about the role investor expectations play in your own investment approach and the advantages you have over professionals.
I will slowly build positions as time passes. In the meantime, I will do my best to support profits while reminding my wife that each drink I pour gets us a little closer to our financial goals.
Email me at [email protected] with your thoughts.
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What i’ve been eating
You may wonder what I’m doing at a French restaurant in Bangkok. It is a good question. When I travel I try to mostly eat local but I do make occasional exceptions. I first went to Le Normandie about 15 years ago and have returned many times over the years. Fresh off a recent renovation and with Anne-Sophie Pic taking over the kitchen I had to give the latest iteration of this 67-year-old restaurant a try. The menu was not as traditional as it used to be but there were some wonderful dishes. Below is one of them. Les Berlingots ASP is one of the signature dishes at Pic’s restaurant in Paris. This iteration was small pasta parcels filled with camembert and served with chamomile, saffron and tomatoes.
