The Fool Buys Starbucks

In honor of The Motley Fool's 10th anniversary, we're looking back at some of our most memorable moments and favorite columns. Today, we'll revisit July 1998, when the Rule Breaker Portfolio announced it would buy $13,000 worth of Starbucks (Nasdaq: SBUX  ) .

It's interesting to note how much -- and yet how little -- has changed with Starbucks' story. This buy report, with a few updated numbers and facts sprinkled here and there, could be rewritten nearly verbatim today.

Jeff Fischer (who wrote this report), and David Gardner, got into Starbucks six years after its IPO, when skeptics were still predicting the "coffee fad's" end. They were accused of moving too late and paying too much for the company in 1998. Even within the Fool, fellow analysts like Dale Wettlaufer (whom we recognized recently for his seemingly prescient Cisco call) didn't get what all the "brew-ha-ha" was about.

When the Breaker boys moved on Starbucks, its market cap was $4.59 billion. Today, it's $10.6 billion, and the stock has split twice. While the company's trailing 12 months' sales at the time stood at $1.119 billion, it now pulls in close to $1 billion in revenues every quarter. Back in 1998, it operated 1,700 stores, and was only beginning its international push in earnest. Today, Starbucks operates over 6,500 stores worldwide, and just opened its first South American store after getting into the Pacific Rim, Middle East, and Europe.

Starbucks' stock has risen from the Rule Breaker's split-adjusted buy price of $13.98 to its current $27 levels. This chart, which tracks Starbucks vs. the S&P 500 over the past five years, dramatically demonstrates how the stock has stayed strong as the market has wilted.

Jeff's detailed report is in two parts, and both are worth a close read. We'll pull some paragraphs from it for a condensed version, but to take in the whole thing, start here. Part Two can be found here.

July 1, 1998

If you'd come by and toured Fool Global HQ at any point over the past year or so, you might have seen this one coming.

Alongside Coca-Cola (NYSE: KO  ) cans, Amazon.com (Nasdaq: AMZN  ) packages, and smiling jesters, one can't help but notice Starbucks coffee cups sitting atop one desk or another (or another next to that). Yep, there's a Starbucks across the street from our Fool HQ in Alexandria, Virginia, though proximity isn't the only reason we find ourselves slurping its products every day. The real draw is that Starbucks is just plain hard to beat.

Embodied in the logo and brand name of Starbucks is consistent quality, dependably quick service, and an interesting and ever-growing variety of products (this summer will pass by a bit cooler thanks to the company's iced drinks). The variety of tasty beverages at Starbucks alongside aggressive store expansion has resulted in a wide and growing customer base -- one that becomes loyal as each Fool (err, Starbucks customer) discovers her favorite Starbucks product and returns again and again. The increasingly wide variety of products is also one reason that you see Baby Boomers lounging next to teenagers in these tiny coffee-scented stores every time you stroll by. (Of course, now that we're shareholders, we Fools will never just stroll by again. New Rule: Every time we walk by a Starbucks, we enter and buy!)

The company has been public for six years, so what took us so long? For all the "buy what you are" teaching that the Fool has prescribed, Starbucks should be one of the most widely held stocks in the country, shouldn't it? The old saying, "It was right under our noses," is especially true with Starbucks. Silly as we are, we simply didn't consider it until that fateful day when Fool Port co-manager Jeff Fischer hit himself in the head, leaned over his desk, and whispered to David Gardner: "Hey, what about Starbucks?"

Reasons behind the purchase
First and foremost is the company's dominant position -- it's a world-beater. Ask yourself this question: Who would you name as number two in its niche? If you've even managed to name another company, how far behind Starbucks is it in sales? Yep, we thought so. Next, consider the impressive growth potential of Starbucks going forward. Analysts forecast 34% annualized gains in earnings per share over the next five years... a rate one expects more from a small cap than a mid cap. Third -- or at least somewhere on the list of why we like this stock -- is that this isn't a technology investment. It's good to have the Fool Port invested in something other than networks, wires, and ether. Now we're investing in beans... and a consumer experience that involves drinking and eating rather than surfing the Web and saving data to a disk.

Starbucks shares have returned 32% annually in the past five years, compared to 22% for the S&P 500 (including dividends), but we believe that we're far from too late with our purchase. Thinking Foolishly five and especially 10 years ahead, we expect further good times lie ahead for Starbucks. Indeed, the company claims that it hasn't even finished chapter 3 of its 11-chapter story.

The biz
Starbucks presently operates nearly 1,700 locations, but within weeks of this writing that number will be outdated. The company typically opens a few locations per day. (The record was five locations in a single day in a single Canadian city.) The idea is to maintain a constant presence in people's minds and, much like Coca-Cola, be attainable in every place that people work, play, visit, live, and Fool around. Alongside this, though, Starbucks is conscious of the need to remain a specialty item retailer and not become an overexposed bean seller. It sells premium stuff -- only really good stuff -- and it needs to maintain an air of exclusive quality while being omnipresent. The balance is delicate.

Starbucks sells more than just beans, though. It sells various items through several growing and new markets. The retail outlets are meant to provide a daily consumer experience that is specialized, but the quality of Starbucks coffee means a potential for strong bean sales in grocery chains, too, as well as branching into other branded products such as ice cream, for example.

The competition
We thought about following this sub-heading with nothing but white space -- empty, blank, nada. Then we thought better of it. We have more to say about competition in a following section about "Risks," so we will keep this section brief for that reason and for the very reason that, to date, Starbucks has been frothing the competition left and right. It's difficult to even determine the number two player behind our numero uno Coffee Guy.

The risks
In the end, no matter what Starbucks is selling or how good it smells, the stock represents a retail business, and retail often makes for a tough investment.

There are some stand-out companies in this industry over the past decade or two (Home Depot (NYSE: HD  ) , Gap (NYSE: GPS  ) , Starbucks, McDonald's (NYSE: MCD  ) , Sears (NYSE: S  ) ), but for every restaurant or retailer that flourishes, 10 or more languish longer than a deadbeat relative with nowhere to go. The industry is difficult because consumer tastes can be fickle and competition is, or eventually becomes, intense. As a result, retail businesses are typically low margin. Every time you hear the cash register ring in the checkout lane, the company is usually only making a few pennies on each dollar spent.

That said, being a lower-margin business isn't horrible as long as inventory turnover is steady and high. It's the amount of dollars that a company brings to the bottom line that truly matters. Plus, Starbucks has better profit margins than many retail outlets, and it stands to continue improving as the company reaches greater efficiencies of scale and increasingly diversifies revenue streams. The majority of its sales will derive from retail stores, though, and as the company adds 1,000 locations or more by the year 2003, this will become increasingly true.


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