You Won't Believe How Easy It Is to Earn a 500% Return From Starbucks

Ken is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Valuing investments can be an exceptionally complicated endeavor. Creating a valuation model is a herculean task and then filling in the data in the model is a process in educated guess work. Figuring out the correct data takes hours and the result is, more often than not, “Garbage In – Garbage Out” (GIGO). Instead of diving into garbage numbers or burying my head in the sand, I take a blended approach to equity valuation and analysis. This blend of qualitative research, soft quantitative analysis, and a healthy dose of patience has helped me become a top-rated investor in the Motley Fool’s CAPS system. 

I believe anybody with curiosity, the support of the Motley Fool's intelligent community, and high-school algebra skills can replicate my market trouncing success. I’ll demonstrate my approach by taking a shot of delicious espresso and diving into one of my favorite companies – Starbucks (NASDAQ: SBUX). Follow along as I explain how I earned a 500% return with relatively little effort, and how you can too.

The Siren’s Song

I started my investment in Starbucks in March 2007 with next to no knowledge of how investing works. All I knew was that lines at Starbucks were typically long and people always thought the drinks were expensive. Even though I wasn’t a business genius, I figured that lots of demand for a high-priced cup of coffee should turn into a decent investment. I opened up a discount brokerage account and plunked down a couple hundred dollars on shares of Starbucks priced around $32.00. As luck would have it, my timing could not have been worse. As the economy contracted throughout the next two years, I saw my investment crash all the way below $9.

<img src="http://media.ycharts.com/charts/cefc1785c810bc13fe4f7e86eda4616f.png" />

SBUX data by YCharts

During those years, I was reading and studying about Starbucks and Howard Schultz. I read Shultz’s biography and began to admire him as a world class leader. Despite the steady drumbeat of horrid financial news and reports of Starbucks shuttering hundreds of stores, I ignored the short-term news and decided to add to my position. I bought Starbuck’s in the $25 range, at $20, at $16, and then I bought at $9. Just a few hundred bucks here and there. Two things kept me from bailing out of my investment at the darkest hour: My research into Schultz’s leadership and the huddle of fellow netizins on the Motley Fool’s Stock Advisor discussion boards who advised staying the course.

With time and patience, something occured that changed my investing life forever. The economy began to slowly turn around. My Starbucks shares started showing some life. First, I broke even on my investment. Months later I noticed a 100% return. Some people would jump ship after doubling an investment. Luckily, I believe in buying and holding for the long run. I started to see the new food initiatives Starbucks rolled out. Expansion into China returned with gusto. The threat from low-priced coffee and so-called lattes from McDonald’s (NYSE: MCD) failed to make a dent in Starbucks' market share. Instead, Starbucks partnered with Subway and Burger King to deliver its Seattle’s Best brand to the masses. To Starbucks' credit, Burger King’s North American restaurant sales beat expectations last quarter while McDonald’s slipped. It looks like the Siren is backing the winning horse.

Lately, Starbucks has been firing on all cylinders. It is reporting great numbers from its Evolution Fresh Juice and La Boulange Bakery acquisitions. Add in tucking in Teavana, opening stores in India, the Square Credit Card Reader, a rabid social media fan base and it is safe to say that Starbucks learned the lessons of the great recession and is set up for another five years of market beating returns.

Just check out this chart to understand why I’m so happy that I didn’t follow the short-term numbers and sell Starbucks at its darkest hour. Starbucks is thrashing the market!

<img src="http://media.ycharts.com/charts/4af8684b4a90d8b3797cadaa097c8241.png" />

SBUX data by YCharts

The shares I bought in March 2007 are beating the S&P 500 and the shares I bought at $9.00 have returned about 500% in a few short years.

Starbucks is doing better than ever. The economy is doing better than the darkest days of 2009, but it is still on shaky footing. In a couple months, Congress will have another budget showdown and I think the markets will get choppy. With my qualitative analysis of Starbucks complete, it is time for me to use my back of the envelope valuation to figure out a good price to add to my winning Starbucks position.

An Easy Way to Value Starbucks 

First, it is a good idea to take a glance at Starbucks' balance sheet. The company has more cash than debt to the tune of approximately $2 billion. This means we don’t have to worry about the company’s ability to pay its debts. Some might subtract Starbucks' cash from its market cap to come up with an enterprise value, but I think Starbucks shows a willingness to use its cash to fund acquisitions and renovate stores. $2 billion is a tidy sum, but I’m going to be conservative and ignore it for valuation.

Starbucks is targeting earnings growth around 15%-20% for the next few years. For my valuation, I’ll take the mid-point of that growth and assume 17.5%. If you want to be more conservative, you should lower the number, but I’m confident that the business will continue to thrive for the next decade. Some investors would balk at this point. The price-to-earnings ratio for Starbucks is over 30. Most like a p/e that is at least in-line with potential growth.  For Starbucks, investors are paying up for quality. I’m not afraid of buying quality at a decent price, so I’ll do a little valuation work to figure out a good place to add to my shares.

For 2013, the company is guiding a bit over $2.00/share for earnings.  I’ll guess Starbucks earns $2.07 per share for 2013 and then start to compound eps growth by 17.5% for the next five years.

 

<img src="/media/images/user_13012/sbux-eps_large.JPG" />
 

Currently, Starbucks fetches an earnings multiple near 30. I want to trim back my expectations, so I’ll guess that Starbucks will trade around a p/e of 20 in 2017 (for comparison, the much more mature McDonald's, trades with a p/e around 17). Multiplying my eps target of $3.95 by 20 gives me a price target of $79/share. Starbucks will trade at a higher or lower multiple, and eps will most certainly not be $3.95/share, but I’m shooting for a quick and dirty estimate. 

Before I decide my buy in price, I need to remember to add in Starbucks' dividend. Currently Starbucks pays $.84/year and has been raising the dividend steadily over the past couple years. I’ll assume Starbucks' will raise its dividend by $.12 each year for the next five years.

 

<img src="/media/images/user_13012/sbux-dividends_large.JPG" />

The total of my dividend estimate adds up to $5.40/share over five years. 

If the political turmoil in Washington D.C., or any of the inevitable fears du jour pop up, I think I’ll give strong consideration to adding to my stake at $50/share. This is my logic: I reduce my cost basis by the dividends I expect ($50.00-$5.40). That adjusts my cost to $44.60 five years from now. My price in 2017 is $79. That return is 77% or around 12% annualized.

12% is solid return from a world class company. A 12% return will almost certainly cream the S&P’s longer-term average of around 8.5%. My return could turn out to be much higher. If Starbucks grows earnings over my 17.5% target, or if investors pay more than a multiple of 20, my returns will soar. And remember those shares I plucked from the darkest days of the recesion at $9.00? Those shares will hold paper returns near 900% in less than 10 years if my earnings estimates are accurate. Do you hold many mind-blowing returns like that? Are you suprised how easy investing really can be? 

Buy Quality & Don’t Worry About the Short-Term

I think these numbers are well within reason. If Starbucks dips back to the $45/share range, I’ll return to my “great recession” strategy and continue to buy at better and better value points.  It was hard to stomach buying when Starbucks was crashing to $19, $16, and $9, but I sure am happy to hold those shares today. As long as Mr. Schultz is as at the helm, and as long as Starbucks continues to expand its offerings throughout the world, I believe I will do just fine.

The bottom line for investors is this. Don’t be afraid to pay up for a quality company. When macro-econonic events start heading south, dig in and start to read. If your company is truly great, then add to your position. Let time and the company’s leadership help your shares grow. Remember not to sell too soon when you make your first 100% gain. Don't let the complexity of valuation scare you away from trying. Most every model is wrong, so don’t spend your limited research time creating GIGO formulas that will help you miss the forest for the trees. Don't let little bumps in the road scare you away from your investment. There will always be a theoretical competitive threat from companies like Dunkin Brands (NASDAQ: DNKN) and Green Mountain Coffee Roasters (NASDAQ: GMCR).  

It is good to keep an eye on these competitive stories, but don't pull the trigger at the first sign of struggle. If McDonald's entrance into high-end coffee scared me off years ago, I wouldn't be sitting on a 500% return today. In soft economic years, some customers will trade down to the less expensive fare at Dunkin’ Donuts and McDonald's. I’m bargaining that over the long haul, these customers will return to the Siren because of quality coffee and best in class food.

Green Mountain shook up the market with its Keurig individual coffee serving system. Starbucks proved its dominance when it was able to craft a deal to serve its own coffee in the Keurig and then created a superior single-cup system with its Verismo system.  Remember that these threats will occur over and over. But we stick with Starbucks it has demonstrated the creative thinking to overcome these threats with innovation and superior product quality.

If you don’t already own Starbucks shares, I think you should consider buying some today. If you already own Starbucks like I do, then I think you’ll be pleased by adding below $50/share and letting time percolate your investment into a mind-blowing return.


BoiseKen owns shares of Starbucks. The Motley Fool recommends Burger King Worldwide, McDonald's, and Starbucks. The Motley Fool owns shares of McDonald's and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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