The Intelligent Investor

Starbucks (SBUX) Plunge Is Beginning Of Bad Trend

When stocks are priced for perfection as SBUX is, they are very risky. Just look at today’s 10%+ drop in SBUX shares in a market that is up 1%.

When stocks are priced for perfection as SBUX is, they are very risky. Just look at today’s 10%+ drop in SBUX shares in a market that is up 1%.

My regular readers know that I have, for a while, warned investors that SBUX was overpriced and due for a correction. See “Get Off the SBUX Bandwagon Before It Crashes“.

In my interview on CNBC’s Closing Bell on January 26, I explain why SBUX fell even though they beat estimates and raised guidance. The point is that the stock’s valuation is too expensive. At $46/share, the stock price implies the company will grow profits (NOPAT) at nearly 15% compounded annually for 10 years. That is a high growth rate for a long time – even after a 10%+ drop in the stock today.

My thesis on selling  SBUX is detailed in my 10/4/11 article “Sell Starbucks (SBUX) – Still A Bad Stock“. The key points are:

  1. Why risk money in such an expensive stock when there are many cheaper (and better) stocks available, such as McDonalds (MCD) and Exxon (XOM), both have valuations that imply their profits will permanently decline by 10%+. That’s a lot lower risk than the 15% growth for 10 years in SBUX.
  2. SBUX has lots of competition… from other stores (GMCR, CBOU, PEET, etc)…from customers that home brew, etc. The stock’s valuation implies they practically own the entire market, when they do not and will not.
  3. Commodity prices have little effect on the stock price. Do not buy the stock b/c you think the price of coffee will drop.
  4. K-Cups margins will fall. It is a good strategy and is generating high ROICs, but the packaged food industry is super competitive and it is unrealistic to expect the fat margins SBUX gets now will persist for long.
  5. Int’l growth is not a panacea for profits. (a) Lots of competition there too and (b) consumers abroad are in worse shape than in the U.S. and (c) the company’s brand power is diluted overseas
  6. Momentum investing is a dangerous strategy. It pays to be more selective about the stocks you buy.
  7. The last time SBUX pursued a high-growth strategy, it ended poorly.

Here’s some context on just how expensive SBUX is:

15% compounded annual growth in NOPAT for another 10 years means Starbucks’ after-tax cash flow will, in 2022, be higher than the 2011 NOPAT for Goldman Sachs (GS), Morgan Stanley (MS) – two businesses that have built rather large franchises and substantial competitive advantages. Are you willing to bet that home brewing coffee will be as profitable as investment banking?

SBUX’s NOPAT would also be higher than 2011 NOPAT for Kraft (KFT), which has a slightly larger product offering than Starbucks. It would also be higher than 2011 NOPAT for 3M (MMM), Home Depot (HD), Eli Lilly (LLY) and Altria (MO). Here are my ratings these stocks.

You get the point: SBUX is already priced to become one of the most profitable companies in the US. For an “investor” to own the stock at these levels, he/she must believe that the company’s cash flows will exceed the current expectations by a significant margin.

Maybe you believe Starbuck can do that, but I do not.

With all the cheap stocks in the market (e.g. Most Attractive Stocks), why would any investor want to place a bet that SBUX’s future profit growth would be better than what is already baked into the current stock price.

Discuss this Blog Entry 1

on Mar 2, 2013

This is so true. It is all about taking risks and decision-making. Businesses should know how to do this one. They should know how to weigh things. - Thaddeus Heffner

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David Trainer

Trainer brings insight and transparency to research on stocks, ETFs and mutual funds.
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