Is Brand Incubation the Future for Diageo plc (ADR)?

St. James's Gate Guinness Brewery. Image source: Diageo.

Diageo might not be a well-known name to consumers, but there's a very good chance that you're aware of many of its brands. This London-based alcoholic beverage company is the world's largest producer of spirits and a major player in the beer and wine space, as well. Guinness, Smirnoff, Johnnie Walker, Captain Morgan, Tanqueray, and many others make up this $75 billion company. Having great brands is important, but staying on top requires innovation. Diageo has a system and support network that should allow it to thrive for decades to come.

Localstars and new ones on the wayDiageo breaks itsportfolio of offerings into multiple categories. The first houses the six largest and best-known brands, which it calls "global giants." The second is called "local stars" and consists of brands that may be wildly popular in one country or region but nearly unknown in another. Some of these brands are destined to stay as regional moneymakers, but there is always the possibility that the company can, using its global reach and distribution, push a great local star up to global giant if it thinks the appetite is there. Diageo's third category is "reserve," 12 brands including John Walker & Sons Odyssey, Ketel One Vodka and Bulleit Bourbon.

A couple of years ago, Diageo launched into a partnership with a company called Distill Ventures that invests in smaller spirit brands through either a seed program, for companies about to launch or recently launched, or a growth program, for companies with operations in place that need capital to scale quickly. In exchange for Diageo's capital and operational expertise, Diageo receives an option to buy out the whole company in the future. This is a very small risk for Diageo with substantial upside. The more people interested in quality spirits benefits the company, and hitting on the next Bulleit Bourbon or Tito's Vodka would make the typical seed investment (up to around $260,000)seem like a drop in the bucket.

Coney Island Brewing Co. Hard Root Beer. Image source: Coney Island Brewing Co.

Similar to SamBoston Beer Company entered into a similar arrangement in 2011 with a few former Magic Hat employees who started a company called Alchemy and Science. It became an "independently operated" subsidiary of Boston Beer and now owns four craft beer producers. It purchased Coney Island Brewing Company in 2013 and recently released a wildly popular product called Hard Root Beer that has provided significant growth for the company.

This arrangement differs in some meaningful ways from Diego's Distill Ventures partnership. Boston Beer is using this as a way to stealthily promote good craft beer by using its distribution, money, and know-how, but not its brand name. With a market cap south of $3 billion, solid success from Coney Island, Traveler Beer, Angel City, or Concrete Beach could be a needle-mover for the company.

Diageo is looking to make a series of smaller investments in search of a product that will hit a nerve critically, commercially, and/or geographically. Diageo is almost 25 times larger than Boston Beer by market cap and is looking to add to its portfolio and maintain its lead in the spirits market. The big brands that many consumers know and love will continue to be the driving force for the company, but it's comforting as an investor to know that Diageo is not resting on its laurels. It is trying to keep smaller competitors at bay by acquiring them or out-innovating them.

Buy for the long termIlike both Boston Beer and Diageo as positions in a well-diversified portfolio. Boston Beer offers more upside due to its significantly lower market cap, possibility of being acquired, and the continued growth in the craft beer market. Diageo provides a solid -- and growing -- dividend yield (3%), a position as the market leader, and a massive global reach. They complement each other nicely within my portfolio and I suggest you take a closer look at how they might fit in yours.

The article Is Brand Incubation the Future for Diageo plc (ADR)? originally appeared on Fool.com.

James Sullivan owns shares of Boston Beer and Diageo (ADR). The Motley Fool owns shares of and recommends Boston Beer. The Motley Fool recommends Diageo (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.