Rule Breaker Portfolio

Starbucks Reviewed
Plus, if not now, when?

by Jeff Fischer
(
JeffF@fool.com)

ALEXANDRIA, VA (Aug. 6, 1998) -- When the stock market is declining as it has over the past month, the question of selling often arises even in the minds of otherwise long-term investors. What you need to keep at the front of your mind, though, is why you invested in the first place and your objectives. Beyond that, consider the taxes that you might need to pay upon selling. And finally, think hard about when in the world you would buy stock again if you sold now, and consider what you stand to miss if your luck is anything close to normal.

Knowing the average age of our readers is nearly the same age as the average American (meaning, young! -- with at least ten years to invest before retirement), ask yourself, "If I'm not ready to be a long-term investor now, when will I be? At a later age in life?"

Today stocks rebounded. The Nasdaq leapt 2.3% while the S&P added 0.76%. Le Fool Port was barely able to split the goal posts, scoring a 0.82% gain. Many of our smaller, recently punished Nasdaq stocks bounced like Nike soccer balls on concrete. 3Dfx (Nasdaq: TDFX) was our largest percentage gainer, and Amazon.com (Nasdaq: AMZN) our largest point gainer.

Tomorrow we'll talk Trump (NYSE: DJT) and announce the "Cover the Donald?" contest winner. The winning Fool will be enrolled in Coca-Cola's dividend reinvestment plan. Today, though, we have a different beverage company to address...

STOCK REVIEW

In our methodical review of each Fool stock, it's time to consider our newest purchase. This is a coffee seller that probably all of you know, even though it doesn't advertise.

Starbucks (NYSE: SBUX) Stock Price: $40 7/8 Market Cap: $3.6 billion Trailing Sales: $1.2 billion Price/Sales: 2.91 Last Qtr Sales: $334 million (up 37%) Book value: $8.53 per share Price/book value: 4.8 Recent return on equity: 11.8% Recent Gross Margin: 56% Recent Operating Margin: 9.8% 5-year est. growth rate: 33% P/E on far earnings estimate: 33 Earnings Estimate: $1.20 in FY99 (ended next Sept.)

What caused the Fool to buy it? As explained in the initial Fool Buy Report on the company, Starbucks is expected to grow 33% annually over the next five years, a rate of growth usually found in smaller and less certain investments. We love the business and how Starbucks has redefined the coffee experience on a national level. We also love the opportunities that the company is seizing in new diversified lines of business, including ice cream and bottled beverages, as well as internationally. This six-year-old public company has mounds of room for growth over the coming decade. The current store count of 1,700 is expected to surpass 3,000 in the next five years, with 1,000 stores opening in new international markets.

What has happened since the purchase? The Fool bought Starbucks on July 2. Since then, the stock hasn't simply fallen, it has fallen off a cliff. In fact, a graph of the stock price shows a decline that mirrors the path of a helicopter after it hits a cliff wall -- only pieces remain, and they drop straight down to earth, lifeless. That's how the Starbucks graph appears since the Fool bought in -- broken, jagged, and straight down.

Why?

The company announced third quarter results in line with expectations, but then during the conference call it guided 1999 earnings estimates to the conservative side. Analysts' earnings estimates stood at $1.17 to $1.30 per share and management said to expect $1.20 to $1.25. The stock took the news badly and fell sharply the next day. Then, last week Starbucks announced July sales that were on the light side, with same-store sales growth of 2% compared to the typical 4% to 6%. The stock continued to decline, eventually falling 33% from its recent high.

However, nothing has fundamentally changed with the business. Sales of the new ice cream and bottled beverage products are strong and moving into profitability, if not already there, while traffic at retail outlets has been hitting record levels. July was lighter than one would hope, but monthly variations are expected -- plus, July was one hot month across most of the country. In fact, reports are rolling in that several Starbucks locations in Texas actually melted to the ground, like giant scoops of ice cream, leaving only stains along the sidewalk. This sort of heat has an impact on same-store sales.

What lessons have been learned? If anything, we bought the stock at a dear price -- for the near term at least.

The implied YPEG value of Starbucks when we purchased was $42.50. That was stated in the buy report. We wrote the buy report and committed to it when Starbucks was trading at $48. The company deserved a premium valuation we believed -- and still believe -- so we were willing to pay up for it. We're banking on a long-term win, but we were reminded that sometimes (often, in fact) investors simply have near-term bad luck. The stock jumped to $56 before we could buy it. We bought SBUX on the day after the purchase report was announced, but the stock had already jumped that day. It then traded in the $56 range over the next five days anyway, so our purchase price was sealed by our own Foolish 5-day buy policy (we wouldn't have it any other way, though, of course!).

The lesson is a mixed one. 1) Sometimes it pays to wait for "your price," which could have been $43 or below (which we've now seen) or the YPEG value. 2) But, in the same breath, sometimes you end up paying if you wait for your price. Waiting to buy America Online four years ago or Amazon.com last year would have only squeezed us the wrong way, and hard. We would not have seen an agreed upon "fair valuation" at which to buy those stocks. We couldn't be sure we would with Starbucks, either.

Luckily, the Fool's situation is more black and white than most. Many of you buy stock regularly, every time that you get paid, perhaps. You have the opportunity to dollar-cost average into positions, so your initial purchase prices aren't often so important. The Fool Port doesn't have that luxury -- it never adds cash to its coffer. That being the case, perhaps in the future we'll be more patient if the situation merits and wait and hope for "our price," rather than granting even leading companies 20% premiums and immediately buying. This "waiting" can be a risky venture, though, and if you're truly in for the long term, the merits of waiting can decrease.

What could cause the Fool to sell it? Coffee is one of the oldest beverages in the world, and one that's now enjoying renewed vitality in many geographies. Starbucks is at the forefront in its markets. If the company can't find a way to consistently grow sales and earnings over the long term in this giant market (it owns far less than 1% of the world coffee market), then we'll dump it. That, or due to other unforeseen events. Right now, though, selling is about the last thing on our minds.

For other reading: Tonight, Cash-King explains how to buy stock for minors, a great topic. Meanwhile, in the Drip Port we're close to determining our financial stock purchase. Tonight I reviewed Mellon Bank -- a diversified leader that has been around longer than Coca-Cola. Finally, the Boring Port discusses Cisco Systems and FelCor.

Wherever you are in the world, thanks for being a part of the Fool community tonight, and have a Foolish evening!

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Bookmark Live Fool Port Quotes

08/06/98 Close
Stock Change Bid ---------------- AMZN +3 1/16 109.25 AOL -2 1/8 105.38 T + 3/4 58.25 DJT + 3/8 6.63 DD +1 5/8 63.38 XON -1 1/4 64.94 INVX + 3/4 13.25 IP - 3/8 42.63 IOM + 1/8 5.00 KLAC +1 7/16 29.13 LU +1 11/16 92.06 SBUX +1 3/4 40.75 COMS +1 25.75 TDFX +1 3/16 14.56

Day Month Year History Annualized FOOL +0.82% -4.44% 40.54% 371.66% 47.33% S&P: +0.76% -2.77% 12.28% 137.71% 24.15% NASDAQ: +2.32% -2.29% 16.50% 154.04% 26.23% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 105.38 2797.75% 9/9/97 580 Amazon.com 19.11 109.25 471.67% 5/17/95 1960 Iomega Cor 1.28 5.00 290.50% 10/1/96 84 LucentTech 23.81 92.06 286.69% 8/12/96 130 AT&T 39.58 58.25 47.18% 4/30/97 -1170*Trump* 8.47 6.63 21.77% 2/20/98 215 DuPont 59.83 63.38 5.92% 2/20/98 200 Exxon 64.09 64.94 1.32% 2/20/98 270 Int'l Pape 47.69 42.63 -10.62% 7/2/98 235 Starbucks 55.91 40.75 -27.11% 8/24/95 130 KLA-Tencor 44.71 29.13 -34.86% 1/8/98 425 3Dfx 25.67 14.56 -43.26% 8/13/96 250 3Com Corp. 46.86 25.75 -45.05% 6/26/97 325 Innovex 27.71 13.25 -52.18% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 74816.25 $72234.38 9/9/97 580 Amazon.com 11084.24 63365.00 $52280.76 5/17/95 1960 Iomega Cor 2509.60 9800.00 $7290.40 10/1/96 84 LucentTech 1999.88 7733.25 $5733.37 8/12/96 130 AT&T 5145.11 7572.50 $2427.39 4/30/97 -1170*Trump* -9908.50 -7751.25 $2157.25 2/20/98 215 DuPont 12864.25 13625.63 $761.38 2/20/98 200 Exxon 12818.00 12987.50 $169.50 2/20/98 270 Int'l Pape 12876.75 11508.75 -$1368.00 8/24/95 130 KLA-Tencor 5812.49 3786.25 -$2026.24 7/2/98 235 Starbucks 13138.63 9576.25 -$3562.38 6/26/97 325 Innovex 9005.62 4306.25 -$4699.37 1/8/98 425 3Dfx 10908.63 6189.06 -$4719.56 8/13/96 250 3Com Corp. 11715.99 6437.50 -$5278.49 CASH $11876.47 TOTAL $235829.40

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Note
The Fool Portfolio was launched on August 5, 1994, with $50,000. It was renamed the Rule Breaker Portfolio in October 1998. The investing strategy began with the first investments of the Fool Port and has evolved with time and experience. In July 2001, the portfolio began adding $12,500 each quarter (We missed Jan. 2002, so we added $25,000 in April 2002). We skip a quarter if we have enough uninvested cash or cash available in stocks we would prefer to sell to make new investments. All transactions are shared and explained publicly before being made, and returns are compared in each week's column to the S&P 500 (including dividends where noted) and the Nasdaq composite. For a history of all transactions, please click here.