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Is Now the Right Time to Buy Starbucks Stock?

By Andrés Cardenal - Mar 8, 2016 at 2:30PM

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Will Starbucks continue delivering caffeinated returns, or are the best days already in the past for shareholders in the coffee emporium?

IMAGE SOURCE: STARBUCKS.

Starbucks (SBUX 0.12%) has been one of the most extraordinary success stories in the consumer sector over the last several years. Shares of the coffee emporium are up by an impressive 285% over the last five years on the back of highly caffeinated global expansion and smoking-hot financial performance.

On the other hand, past performance is no guarantee of future returns, growth tends to slow as a company gains size, and Starbucks stock is priced at a premium versus the broad market. Besides, Starbucks operates in a remarkably competitive industry, and McDonald's (MCD 2.02%) has recently introduced its all-day breakfast menu in the U.S with remarkable success. 

Is now the right time to buy Starbucks, or are the best days already in the past for investors in the company?

Some important risks to watch
Starbucks stock trades at a price to earnings ratio of 36. That's twice the S&P 500, which is currently trading at a P/E ratio of 18. And companies in the restaurant space trade at an average P/E ratio of 29, according to data from Morningstar.

Starbucks is a high-quality business and thereby earns its premium valuation. But at its current price, the stock is vulnerable to investor disappointment -- for example, if the company's growth were to decelerate. Starbucks already has 23,571 stores around the world, and it's not easy to continue finding promising new locations when you've reached such a massive scale.

Success also attracts competition. McDonald's launched its all-day breakfast menu across the U.S. in October 2015, and it has been a major success for the fast-food giant. After several quarters of stagnant or even declining sales at home, McDonald's announced a 5.7% increase in comparable store sales in the U.S. for the quarter that ended in December.

Can Starbucks keep delivering?
No company is immune to competition, but Starbucks has nevertheless delivered impressive returns over the years for investors, and there is no reason to believe that even McDonald's can derail Starbucks from its long-term trajectory. 

Starbucks benefits from enviable competitive advantages. Brand differentiation, a reputation for quality, and a unique customer experience make it one of a kind. The company gets to sell its products for premium prices because customers appreciate these characteristics. Starbucks is also well ahead of the competition when it comes to technological innovation. Nearly 21% of all its transactions in the U.S. were paid via mobile applications last quarter, which means both a better experience for customers and more efficient operations for the company.

Starbucks is the market leader in specialized coffee, particularly at the high end of the price spectrum. While McDonald's can gain ground with competitively priced products, chances are that it will steal market share away from lower-priced competitors as opposed to Starbucks.

Judging by the latest financial report from the company, Starbucks has been firing on all cylinders, and there is no sign of a slowdown in growth. Total revenue increased by a healthy 12% last quarter, reaching a record $5.4 billion. Global comparable sales grew 8% on the back of a 4% increase in traffic versus the same quarter in the prior year. 

Even in the U.S., the company's most mature and highly penetrated market, comparable store sales jumped by 9% last quarter. This shows that demand remains remarkably strong, and that new store openings are not cannibalizing sales from existing locations. Product innovation is a major growth driver for Starbucks, and the company is expanding not only in coffee, but also in areas such as tea, juice, and food.

On a global scale, Starbucks still has a lot of room to expand its geographic presence. The company opened 150 new stores in China last quarter, and is planning to open 500 new stores annually in the country over the coming five years. While product innovation will be the main growth driver in the U.S., Starbucks should profit from both new products and a wider geographic footprint internationally over the long term.

Everything indicates that Starbucks will continue delivering above-average growth rates in the future, so its premium valuation is no reason to stay away from the company's stock. While it is always important to watch out for changes in the competitive landscape, Starbucks is second to none in terms of brand power and competitive differentiation in its industry. All things considered, Starbucks stock looks well positioned to continue delivering rock-solid returns for investors in the years ahead.

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Stocks Mentioned

Starbucks Corporation Stock Quote
Starbucks Corporation
SBUX
$76.43 (0.12%) $0.09
McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$247.74 (2.02%) $4.91

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