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Reading the Starbucks Coffee Leaves
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By deadcat2
February 23, 2007

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Let me preface by saying I'm not really a chartist, but I couldn't help noticing an interesting pattern with SBUX. Take a look at this chart. If you only see the 1 year chart for Starbucks, input these values to see what I saw: Under chart options, "4 years" and "Weekly." On the Lower Indicators, select "Rolling EPS", "P/E Ratio" and "RSI."

What is striking is that over this timeframe, as SBUX approaches a P/E of 40, the P/E and the price suddenly bounce back up again. Someone else recently commented that "investors are not currently willing to pay 50x earnings". It does seem, however, that they're willing to jump on the band wagon at somewhere close to 40x earnings.

While not a technical analyst kinda guy, I do think that ratios like P/E can be a good measure to track, especially with a stock like SBUX. Also called Investor Sentiment (or ISM), the p/e can give a good indication of what kind of multiple on earnings that investors are willing to pay for a stock over time. Some of the DOW component stocks are a good example of the prolonged willingness of investors to pay a much higher multiple for earnings than the growth rate would generally suggest (another of my favorite ratios, PE/G). DuPont, for example, carries a P/E that is about twice its earnings growth rate. Of course some of that high P/E can be attributed to the certainty and size of the dividend DD has always paid.

SBUX, with no dividend, appears to carry an average ISM of about 50 (I'm just eyeballing the chart), also about twice it's growth rate. While it's hard to predict the direction that SBUX stock might take at a multiple of 50 or above, the pattern so far has been pretty clear that it's on its way back up when the multiple dips close to 40.

Looking further back, it appears this pattern remains intact, although the bounce back point is a little lower, at multiples in the mid-30s. Of course the runup is also far higher in those days, even approaching a multiple of 100 back in late 2000.

So what's all this mean? For one, SBUX is maturing - the spread between the high and low multiple is moderating. Over the years, investors have come to believe (and expect) that SBUX can in fact grow their earnings at a fairly predictable rate, just like they say they will. My theory is that that expectation has come to command a higher minimum multiple (and with that predictability, also a lower maximum multiple).

The last time I bought SBUX it was sporting a multiple of around 45, and that was after a haircut in the stock price of about 30%. It's gone on since then to increase in value five fold (I'm glad I never sold when it hit those high multiples)! I haven't added to my position since then, but I'm reconsidering now. A price of around $30 gives it a multiple of 40. It may not reach that price, but even at today's average price of $32.50, a 20% increase in the months ahead does not seem like a stretch. A return to a multiple of 50 at some point in the future is almost guaranteed, and with 2008 earnings projected at $1.08... hmm, let's just say I like the math :)

Derek
(wondering why he didn't think to add to winner before)


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