Is Starbucks a Buffett Stock?

Warren Buffett attracts a lot of attention. As the world's third-richest person and most celebrated investor, thousands try to glean what they can from his thinking processes and track his investments.

While we can't know for sure whether Buffett is about to buy Starbucks (Nasdaq: SBUX  ) -- he hasn't specifically mentioned anything about it to me -- he's left us some clues as to whether it's the sort of stock that might interest him. Answering that question could also inform whether it's a stock that should interest us.

In his most recent 10-K, Buffett lays out the qualities he looks for in an investment. In addition to adequate size and a reasonable valuation, he demands:

  1. Consistent earnings power.
  2. Good returns on equity with limited or no debt.
  3. Management in place.
  4. Simple, non-techno mumbo jumbo businesses.

Does Starbucks meet Buffett's standards?

1. Earnings power
Buffett is famous for betting on a sure thing. For that reason, he likes to see companies with demonstrated earnings stability.

Let's examine Starbucks' earnings and free cash flow history:

Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.

Source: Capital IQ, a division of Standard & Poor's. Free cash flow is adjusted based on author's calculations.

After enjoying tremendous growth for a long time, Starbucks hit a speed bump over the past few years as it suffered from overexpansion, though the company is turning things around.

2. Return on equity and debt
Return on equity is a great metric for measuring both management's effectiveness and the strength of a company's competitive advantage or disadvantage -- a classic Buffett consideration. When considering return on equity, it's important to make sure a company doesn't have an enormous debt burden, because that will skew your calculations and make the company look much more efficient than it actually is.

Since competitive strength is a comparison between peers, and various industries have different levels of profitability and require different levels of debt, it helps to put them in context:

Company

Debt-to-Equity Ratio

Return on Equity (LTM)

Return on Equity (5-year average)

Starbucks

16%

26%

21%

Peet's (Nasdaq: PEET  )

0%

13%

8%

Caribou (Nasdaq: CBOU  )

0%

14%

(16%)

Green Mountain Coffee Roasters (Nasdaq: GMCR  )

41%

16%

16%

Source: Capital IQ, a division of Standard & Poor's.

Among the pack, Starbucks generates the highest return on equity while still employing minimal debt.

3. Management
Howard Schultz founded the company in 1985 and was CEO until 2000. He returned to the job in 2008.

 4. Business
Coffee isn't an industry that's particularly susceptible to technological disruption.

The Foolish conclusion
Whether or not Buffett would invest in Starbucks, we've learned that, should Schultz succeed in his turnaround efforts, the company exhibits many characteristics of a quintessential Buffett investment: consistent earnings, high returns on equity with limited debt, and a long-tenured CEO.

Ilan Moscovitz doesn't own shares of any company mentioned. Green Mountain Coffee Roasters is a Motley Fool Rule Breakers selection. Starbucks is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


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