On their quarterly conference call earlier this week, Starbucks (SBUX) management indicated they envision room for 30,000 of their stores worldwide. Given that after years of rapid expansion they have yet to even reach 9,000, we can assume sleep is not something the Seattle-based premium coffee chain focuses too much on.
The stock has been on fire, having doubled in price over the last year to a recent $55 per share. Is it too late to get in? Well, it depends on your personal investment philosophy. Momentum investors love to see stocks like Starbucks defy gravity, and there is no doubt they have contributed greatly to its meteoric ascent lately. The question is, what can investors expect in the future?
I can’t recall a time Starbucks has been this richly priced. The p/e has actually risen throughout this year, despite the fact that multiples usually contract when larger companies get big enough that growth will inevitably have to slow. Fiscal 2005 earnings are expected to rise another 20% to about $1.14 per share, giving SBUX a forward p/e of 48. Much like one of their hot chocolates, the shares seem very, very rich.
Starbucks bulls can surely explain why the company deserves such a valuation. Among them, a 20% growth rate, the ability to charge $4 for something that one can buy somewhere else for $1 even though it is not four times as tasty (some may disagree), and the list goes on. The S&P 500 does trade at about two times its growth rate, so perhaps one can justify a 40 p/e for Starbucks stock. Given the company’s 30,000 store goal, it’s clear that the growth story is not going to end anytime soon.
The question remains, how long can the company maintain its 20% annual growth rate? And importantly for investors, what happens to the stock’s 48 forward p/e when growth slows to 15 percent, and then to 10 percent? That multiple clearly has little room to rise, and a significant way to fall at some point in the future. The stock’s upward move has actually accelerated over the last year or so, as momentum investors have chased the stock. This despite the fact that as the company continues to grow, it will become harder and harder to maintain its high level of growth.
If you have a sizable capital gain in Starbucks stock, perhaps it would be prudent to take some of it off the table. Here is one statistic to end with. Assume SBUX is able to maintain its 20% earnings growth rate for the next three years, through 2007, and as a result, posts 2007 earnings of $1.64 per share. If the stock trades at a 40 p/e at that time, then shares will fetch about $65 each. This would imply a return to investors of 6 percent per year between now and 2007. Hardly breathtaking, but surely a possible scenario.