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An Entry Point for Starbucks
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By jesting2
June 22, 2007

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Greetings Fools,

A little over a week ago, collegeeducated posed the question of what a good entry point might be for SBUX. I missed getting in on that thread and since it is a bit old, I thought I would post my response in a new thread.

Entry point for Starbucks:

As a current owner of SBUX, I believe that what we are seeing today is a temporary price adjustment or a pause that is normal with every company. No stock can go up continuously, and these setbacks provide opportunities for long term holders to add to their positions. The question though is what would be a good entry point? Here are some thoughts on this question.

The current price as I write this is $25.85 which, with trailing 12 month earnings of $.80, means that the stock is trading at 32.3 times trailing earnings. (29.7 times fiscal 2007 earnings estimates)

The average P/E for the fiscal years 1996-2005 was 45.1 times (The high average was 59.4 and the low was 30.8.) The average P/E for the period 2001-2005 was 40.5. (High of 50.6 & low of 30.3) Looking at the trend it is quite obvious that the company is showing distinct signs of maturing and investors are less inclined to pay the higher multiples they were when the company was smaller and capable of growing at higher rates. The natural restrictions of volume growth as a company gets larger are starting to be felt in P/E shrinkage. At least at the top end where the annual high P/Es have dropped from the mid 70s to the low 50s.

On the other hand, the average low P/E has stayed pretty much unchanged and in fact, the low P/Es have remained in a narrow band between 26.2 (2002) to 36.5 (2005). I see this as evidence that while investors are no longer confident that the company can grow as fast as it did earlier, they are confident that earnings are likely to experience sustained if lower growth. They are willing to pay about 30 times earnings. This would be an appropriate premium for a company growing its earnings in the 20-23% range.

Now the question is, looking forward, what should we expect SBUX to earn, at least in the next few years. The company has provided guidance that fiscal 2007 will come in around $.87. The street consensus appears to be $.88.

Let us assume that all of us would like to purchase more shares if the company is "On Sale". I believe that it is reasonable to assume that a purchase at the average historical P/E would be a fair value proposition, and that anything under the average would be "On Sale". So how much of a discount would make us interested? How about 20% below fair value. (Admittedly I am using some very arguable percentages here, but I have to start some place right?) OK, lets see where this takes us....

Current fiscal year estimate is $.87 x historical 5 year average P/E of 40.5 x 80% = $28.51. (A 20% off sale price.) So $28.51 looks like a decent entry point to me. But a lot will depend on what we expect the company to do going forward. For the fiscal years 1996 to 2005, the company grew its earnings at a CAGR of 27.9%. For the period 2001-2005 it was 28.5%. However, if we accept that the company is maturing, we must also expect to see this rate of growth slow down. I am going to arbitrarily cut the growth rate 20%. (Perhaps I am in a 20% rut eh?) Regardless, I think that given the pressures of their margin squeeze and the size of the company, this is a conservative adjustment. So, 28% CAGR x 80% = 22.4% future growth.

If we use the average P/E of 40.5 and apply this to the forward earnings estimates (using the 22.4% earnings growth rate), the future value of the stock would be as follows:

2007 $.87 x 40.5 = $35.23

2008 $1.06 x 40.5 = $43.13

2009 $1.30 x 40.5 = $52.65


Using an entry point of $28.51 and a future value of $52.65 over say a three year period would indicate a compound annual yield of over 22%. If one was fortunate enough to achieve the average high P/E for the last five years of 50.6, the future value might be as high as $65.95 and the yield would be about 32%. That is possible of course, but as discussed earlier, I see the company maturing, and the high average P/E will likely continue to fall. At any rate, a return of 22% on a company of this size is nothing to turn your nose up at.

Conclusion:

It would appear that an entry point of about $28.50 should be a safe bet. If you can get it for anything less, the odds in your favour improve. However, 5 years from now, it will not likely make a lot of difference to you if you enter at $28 or $27 or $25. You will more than likely have a smile on your face.

But right now the price is $25.85. The SALE sign is hanging in the window!

So you are waiting for it to go to what price????

Cheers

Bob


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