Questor share tip: Diageo hit by emerging market fears Diageo needs to expand into emerging markets because earnings growth is becoming challenging in some more mature markets. Group earnings need to continue to grow to support the rising dividend that is so important for investors. In the latest full-year results there was a mixed picture across developed markets. In North America, the group's largest profit contributor, the nascent recovery resulted in volumes rising 5pc and profits 8.3pc as US drinkers continue to lap up "premium" spirits such as Johnnie Walker Blue. Western Europe, by contrast, continues to struggle as hard-pressed consumers in the southern Mediterranean countries and Ireland rein in their spending. The European region delivered a decline in volumes of 3.8pc, while profits were 6.7pc lower. North America and Western Europe combined contribute 61pc of the group's profits. The developed market performance has so far been offset by strong trading elsewhere. Full-year results showed that Africa, Latin America and Asia Pacific regions grew volumes by 9.7pc, 14.7pc and 3.1pc respectively, providing an average growth rate in profits of 14.2pc. The company is now two years into a three-year programme to grow net sales by an average of 6pc a year. However, the drinks giant, which generates 42pc of sales from emerging markets, has been hit by problems in some countries, such as China, where the government has cracked down on lavish entertainment. Ivan Menezes, chief executive, has insisted that Diageo remains "on track" to deliver its medium-term guidance of an average of 6pc net sales growth despite weakness in some countries. So how much do investors have to fear from the emerging market warning from Unilever? As a spirits company, Diageo should be more protected from a slowdown of consumer spending in developing markets. Spirits, in particular the brands sold by Diageo, tend to be bought by the more affluent consumers in these regions. These richer consumer groups are hurt less by a fall in spending power due to currency falls. However, Diageo is not immune to problems in emerging markets. The group warned in its full-year results that it had fallen short of the target to grow sales by 6pc in the year ended July, after it experienced difficult trading conditions in a number of emerging markets, including China and Nigeria. Diageo shares have risen more than 7pc in the year to date and are up 11pc from when Questor last recommended buying them in September 2012. The company offers a forecast dividend yield of 2.5pc. Those dividend payments are expected to grow at almost 10pc for the next two years. However, the shares still trade on a forecast price-earnings ratio of 17.1 times, falling to 15.6 next year, even after yesterday's correction. If one of the cornerstones of the growth strategy that underpins the rating looks like it might be softening, it only seems sensible to be a little bit more cautious on the recommendation. Diageo is still a solid defensive share but the rating is downgraded to a hold.