Starbucks Corporation
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Why own SBUX?

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By 1000
June 17, 2003

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Hi Bwlfool,

Dividends are an important reward to shareholders. I would suggest investors consider companies that pay them and have long history of increasing them. In the same breath, I would suggest buying some companies that are growing and reinvesting cash produced through the operation of their business. This reinvestment of cash flow will produce greater future cash flows, which will be reflected in an increased stock price.

Is Starbuck overvalued?

Its growth rate is estimated to be around 20% for the next five years. It has a PE ratio around 40. By this simple measurement it is overvalued in the short term. A rule of thumb is that the PE ratio should be lower or equal to the growth rate in order to be considered fair value. The unfortunate part is that everyone knows this rule and will bid up a company price quickly to discount future growth.

Full year earnings in 2002 for Starbucks is .55
Price approximately 25
PE ratio 25/.55 = 45

Of course, Starbucks have had a few more good quarters since the end of fiscal 2002.

Estimates for fiscal 2003 .67. So if the price stays the same, the PE shrinks a bit.

25/.67 or a PE of 37.31

The fiscal 2004 estimates are .80. If the price stays the same the PE shrinks further.

25/.80 or a PE of 31.25

The fiscal year 2005 estimates are .96. If the price remains the same the PE shrinks further.

25/.96 or a PE of 26

The fiscal year 2006 estimates are 1.15. If the price remains the same the PE shrinks further.

25/1.15 = 21.

At this point Starbucks would be considered near fair value. And in efficient market perhaps it would actually work out that way.

The fiscal year 2007 estimates are 1.38. If the price remains the same the PE shrinks further.

25/1.38 = a PE of 18.11 In 2007, after five years of waiting JDSU still at 25 is below fair value.
But investors are seldom this logical. And by 2007, they are bidding Starbucks up to reflect earnings that might be in 2012.

As investors, we must consider Starbucks ultimate potential.

There are a couple ways to do this. We can compare the number of stores now with targets set by the management. Today there are 6500 SBUX stores and management goal is to build 25000 Starbucks worldwide. This represents 7 years of 21% growth. But there are problems with this analysis too. Much of this development comes from overseas, which may not be quite as profitable as US stores.

So now what?

We can compare them to existing business models. Maybe one that is paying dividends like McDonalds (MCD). They have 31,000 stores worldwide. Can Starbucks come close to this type of saturation? That is a big question and one that investors are trying to answer.

Can a premium coffee store saturate a market in the fashion of McDonalds? There may not be a real perfect example to cover this question, but history shows that there are parallels. In old London, there were 1400 coffee houses in that one city alone. Now that is real saturation. Read about that.

The same culture that made coffee house popular in old London is the same type of culture Starbucks is pushing in the US today. They are not serving just coffee, they are creating an atmosphere where people can discuss business, socialize and escape the pressures of the outside world.

Starbucks today has a 9.7 billion market cap compared to McDonalds 28.2 billion market cap, or about three times smaller. McDonalds was selling considerably lower in March of this year. They were selling for 12.02.

What did they do to move their stock price? They said they would use future cash flows to pay greater dividends to shareholders. McDonalds was desperate to increase their share price. Growth is slowing. Value Line estimates that MCD will still grow earning by 7% annually for the next five years but the PE is 28. Presently their premium is higher than Starbucks. This shows the power of dividends. Or in this case, just the promise of increased dividends.

But Starbucks doesn't have to resort to such tactics this early in the game. Perhaps when they have grown to 31,000 stores worldwide, they too may have to start paying dividends to prop up their share price, but by then Starbucks will be selling for around $70. Don't ask me when that will be, that is for investors like you to figure out. Now I can guess, but that would ruin the surprise.


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