3 Reasons to Buy This Dirt-Cheap Dividend Stock and Hold It Forever

Share prices of Starbucks (SBUX 1.00%) have been under pressure since Howard Schultz officially stepped back in as interim CEO on April 4. Schultz immediately suspended the company's share repurchase program, which was the largest component of a three-year, $20 billion program to boost shareholder value through dividends and stock buybacks. 

Starbucks stock is down more than 12% in April and over 30% year to date. On sale and out of favor, here are three reasons why Starbucks is a dividend stock worth buying now.

Image source: Getty Images.

1. Upside potential

Share buybacks are a great way for a company to repurchase its own stock at a good price, reduce the outstanding share count, and therefore boost earnings per share. Starbucks has not done a good job buying back its own stock in the past. It bought it back when its stock price was much higher than it is now and failed to buy back significant amounts of shares when the stock price was lower than it is now for most of 2020.

Given the Starbucks stock sell-off, some investors may have been hoping that the buyback program would give Starbucks the chance to buy its own stock at a good price. But investing in the long-term growth of the business could prove to be an even better move.

Starbucks has plenty of opportunities to grow its store count in the U.S., particularly in the suburbs, as well as throughout China and other international markets. However, the even bigger draw is to improve the performance of existing stores by leaning into grab-and-go ordering, improving the efficiency and use of drive-thrus, growing the number of Starbucks Rewards members, and improving the way that those members engage with the Starbucks app.

It's easy to think of Starbucks as this huge company in a saturated market. But if you think about Starbucks' growth through the way in which it sells coffee and food items -- as in through drive-thrus and mobile ordering -- more so than just building more stores, the multi-decade growth trajectory and investment thesis become a lot clearer. In sum, Starbucks can generate a lot more revenue and profit per store, and likely boost its operating margin, by generating more volume per store. And the best way to do that is likely through grab-and-go ordering.

2. The dividend is intact

A stabilizing force of Starbucks stock is its growing dividend, which has increased every year since Starbucks began paying it in 2010. Cutting the buyback program is a separate issue than the dividend. There's every reason to believe that Starbucks will raise its dividend again this year.

The good news is that these dividend raises are predictable -- as Starbucks almost always issues a press release in late September stating the dividend increase. Investors should be on the lookout for this update.

Starbucks needs to show it remains committed to raising the dividend for years to come. If it breaks its 10-year streak and doesn't raise the dividend this year, that would be a major red flag and damage its investment thesis. But for now, there's no reason to believe the coffee giant would go that far.

3. A dirt cheap valuation

Starbucks' price-to-sales (P/S) ratio, enterprise value-to-earnings before interest, taxes, depreciation, and amortization (EV-to-EBITDA) ratio, price-to-free cash flow (FCF) ratio, and price-to-earnings (P/E) ratio are currently below their three-year, five-year, seven-year, and 10-year median levels.

These metrics indicate different things on their own. But together, they show that the value of the business is inexpensive relative to how much it's generating in sales, in earnings, how well it is operating relative to its size, and how expensive the stock is compared to how much free cash flow it is producing.

Data source: YCharts. 

A P/S ratio shows how expensive a company is relative to its revenue. So Starbucks' 3.28 P/S ratio means its market cap is 3.28 times the size of its trailing twelve-month (ttm) revenue. For context, McDonald's (NYSE: MCD) has a P/S ratio of 8.28 and Costco Wholesale (NASDAQ: COST) has a P/S ratio of just 1.28 -- but that's because McDonald's has a much higher operating margin than Costco and therefore generates more profit per dollar in sales. 

The EV to EBITDA ratio is a great way to view the value of a company, including its debt, to its earnings before other accounting factors are involved. It is basically more of a pure form of the P/E ratio, which just shows the company's market cap divided by its ttm earnings. Starbucks' P/E ratio is actually lower than McDonald's, which is 25.49, and Costco, which has a 48.63 P/E ratio. However, McDonald's has proven to be more recession resilient than Starbucks, and Costco is growing faster than Starbucks -- hence its premium valuation.

Finally, price to FCF shows the market cap of a stock relative to its FCF. FCF is important because it shows what is left over to pay the dividend, buy back stock, pay down additional debt, or reinvest in the business.

All four ratios can vary by company and are best monitored through the lens of a company's historical valuation and its closest peers. The lower all four financial metrics are, the less expensive the stock. So having all four ratios below their longer-term medians illustrates just how cheap Starbucks stock is right now. 

A balanced long-term investment

Starbucks is one of the few industry-leading companies and global brands that combines growth, income, and value. Inflation and threats of unionization don't impede its long-term growth plans. Starbucks has become a reliable dividend stock that produces a quarterly passive income stream for long-term investors. And the best part is that the stock is cheap by several different key metrics.

Add it up, and there's every reason to believe that Starbucks is one of the most complete packages on the market today.