Wake Up and Smell the Profits

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

WAKE UP AND SMELL THE PROFITS

Peter Lynch, who ran the Fidelity Magellan Fund when it became the best performing mutual fund in history, was an only investing in things you understand and he publicly stated that he believed the average investor should be able to outperform the average mutual fund because the average investor was not moving enough money in and out of a given stock to actually move the share price; whereas, he was moving millions of dollars at a time and was therefore limited to larger business and stocks that normally traded very large volumes.  He was also fond of looking for investment ideas while going through the motions of his daily life by ovserving what seemed to be popular.  He understood that being a popular stock on Wall Street was not a requirement for having a popular and successful product.

Possibly the greastest advantage we have as individual investors is being able to buy businesses that offer excellent products when they are out of fashion on Wall Street.  You can never overestimate the advantage you have in investing when the only person you answer to is the one in the mirror.  That gives you the ability to practice what one of the most successful investors of all time, Warren Buffet, has said: “Be fearful when others are greedy and greedy when others are fearful.”  Fear is the only thing that causes stock prices to be undervalued and greed is the only emotion that drives them up to ridiculous prices.  Quite often, when I smell fear, I think profit!  Today, I smell fear, but it smells a lot like coffee!  Green Mountain Coffee Roasters (NASDAQ: GMCR) coffee to be exact.

IT’S TIME TO SMELL THE OTHER DRINKS TOO

I know that not everyone likes coffee; some like tea, others prefer hot chocolate and it really doesn’t matter to me what drink they prefer.  All that matters to me is that most people have a hot morning beverage they enjoy, have no intention of changing their existing favorite, only need a cup or two and I can find a way to profit from satisfying that want and desire.  Green Mountain Coffee Roasters doesn’t care what their individual preferences are either, they make a single serving container to produce a beverage for just about any taste.  They also make and sell the Keurig brewer for producing the beverage quickly by the cup.  If you look, you will be surprised how many places you see these systems in place and, believe me, the beverages are really good!  It is the kind of business Peter Lynch just might love.

WHEN WALL STREET LOVES ME NOT

When Wall Street loves a stock, it is normally priced beyond any reasonable valuation even if it were to perform perfectly.  This was the case with Green Mountain Coffee Roasters in 2011 when it was a “MUST OWN” for every portfolio and reached an all-time high price on September 19, 2011 of $111.62/share with projected earnings of $1.44/share for the fiscal year ending September 30, 2011, producing a P/E of 77.51!  It was just hard for me to believe there was a reasonable, fundamental metric by which to value this business at over 77 times current earnings; but, it was a “must own” stock for many people at that time.  Isn’t love grand?

On Wall Street, love NEVER lasts forever and, as in life, the end love does not tend to be pretty or pleasant.  By July of last year, the share price had plummeted to $17.11! As I said, the end tends not to be pretty, unless you are an investor looking for value.  This business was grossly over valued at $111.62/share in 2011 and it was worth a whole lot more than $17.11 in 2012.  Today, the price has rebounded to $45.40 and I believe it now carries a very reasonable valuation based upon its fundamental value and in comparison to its competitors and its anticipated rate of earnings growth.

GMCR has two primary competitors that are publicly traded, Starbucks (NASDAQ: SBUX) and Farmer Brothers Co. (NASDAQ: FARM)Given the size of this market, it is really not overly crowded which is always a good sign; too many players in a space can put a great deal of pressure on margins and profits.  How do these participants stack up against each other and how stable are their business models?

Category                                 GMCR                        SBUX             FARM                        

Debt To Equity                         0.18                           0.11              0.59

Interest Coverage                      22                            N/A                -2.2

Current Year P/E                      16.15                        24.76             56.74

FWD 5-Year Earnings Growth    19.2%                       17.9%           22.89%

5-Year Sales Growth                15.6%                       7.16%           18.03%

5-Year Return on Equity           15.9%                       24.8%            -16.1%

5-Year Return on Assets            9.4%                       13.5%             -9.5%

5-Year Return on Capital         11.2%                       19.5%             -12.4%

When a business is not earning enough money to cover the interest payments on their existing debt, as is currently the case with FARM, there is too much risk involved to justify the allocation of my capital.  Both GMCR and SBUX have managed their debt wisely and it poses no real threat to either business.

While I believe both SBUX and GMCR represent reasonable values at the current share prices, I lean toward GMCR as a better value based upon its slightly better projections for earnings growth and lower current P/E.    For those looking for fair to low current valuations with very good earnings growth potential and share price appreciation over an extended holding period, take a long hard look at GMCR and SBUX then sit back and smell the profits!  Both of these businesses have the potential for double digit annual returns over the next five years.

I currently hold an open March 16, 2013 naked put position on GMCR with a strike price of $42.00.  At this time, should this option expire without assignment of the shares to me, it is my intention to reopen a new position in GMCR.


KenMcG6150 has a position in Green Mountain Coffee Roasters. The Motley Fool recommends Green Mountain Coffee Roasters and Starbucks. The Motley Fool owns shares of 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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