7 Core Growth Stocks for Your Portfolio - Starbucks

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

Investors can prime their portfolio for success by building on a collection of core growth stocks. These are remarkable businesses with the potential to deliver a decade or more of great returns. But to be considered a core holding a company requires 1) a sustainable competitive advantage and 2) a visible growth trajectory. In this series I'll present seven companies that can perform that role.

Starbucks (NASDAQ: SBUX) is the undisputed king of the coffee shop. Twenty years ago, the company imported the magic of an Italian espresso bar and introduced the country to a new language with words like 'Venti' and 'Frappuccino.' Through the company's marketing machine, paying $5 for a cup of joe became an acceptable practice. 

This business has translated into handsome profits for investors. Since the company's initial public offering in 1992, Starbucks shares have posted a 21.4% annualized return. 

Why it's a core stock

Warren Buffett coined the term 'economic moat' to describe the strength of a company's competitive advantage. The size of this moat determines how long a company can keep its competitors at bay while earning excess returns for shareholders. 

Starbucks has one of the widest moats in the restaurant business by selling its customers a premium experience - a relaxing, comfortable atmosphere and a consistent product that most competitors can't match. 

Brand strength equals pricing power. During the height of last year's fiscal cliff negotiations and global economic turmoil, Starbucks introduced its exclusive "reserve line" of coffees for $7 a cup. This is a testament to the loyalty customers have to the company.

Starbucks' massive size also results in economies of scale that few of its competitors can achieve. 

Want to compete against Starbucks? Go right ahead. You're up against a company with the top supply chain, the best CEO in the business, the lowest costs, and dedicated employees. Think you can compete by adding a little local flavor? Good luck with that. 

Both of these factors have resulted in impressive financial performance year after year. 

Many investors mistakenly assume that because there's a Starbucks cafe on every corner that the company must have exhausted its possible growth avenues. But nothing could be further from the truth. 

Consider that Starbucks is just starting its expansion in China, Vietnam, India, Russia, and Indonesia. These countries have a combined population of over three billion people. Assuming Starbucks can penetrate these market to a third of the degree it has in the United States, that's room for 24,500 cafes. To put the number in perspective, that's almost double the size of the company's current North American operations. 

That's a long, visible growth runway! 

Perhaps those assumptions are overoptimistic. But consider that when Starbucks opened its first store in India last year, the line stretched around the block. This demonstrates the global strength on the company's brand. 

Risks to watch

Of course, while Starbucks is a great company today, investors must keep diligent watch to ensure its performance doesn't deteriorate. There are two key risk factors investors should keep their eyes on. 

First: competition. Did you really think Starbucks could get away with selling a $7 coffee without attracting attention? 

McDonald's (NYSE: MCD) has made steady inroads into the coffee market. The company threatens to undercut competitors and has already been successful taking share. Between 2004 and today, McDonald's grew its share of U.S. retail coffee sales from 2% to 7%. Expect those gains to continue as McDonald's completes its McCafe roll-out. 

By 2011, coffee accounted for $2.1 billion of McDonald's $34.2 billion U.S. sales. Don't dismiss a juggernaut with a $100 billion market capitalization and the resources that brings.

Dunkin' Brands (NASDAQ: DNKN) is also expanding westward, threatening to encroach on Starbucks' turf. 

Dunkin's 7,306 U.S. stores are concentrated in the northeast leaving the company lots of room to expand in the Midwest and on to California. Management plans to double its number of U.S. locations by 2033. This year Dunkin' will open 300-360 stores in the U.S. targeting a long-term annual unit growth rate of 4.5% - 5.0%.

Second: execution. Expansion is difficult. Expanding into emerging markets is especially challenging and already we're seeing problems emerge. In May, Starbucks faced a "toilet water" scandal in China. Of course, problems like this threaten the company's brand and derail growth plans.

When you're paying over 30 times earnings for the stock, execution needs to be flawless. 

Foolish bottom line

Starbucks remains the undisputed leader of coffee, and the company's prospects look quite exciting. Of course there's always risk when investing in a aggressive growth stock. But in the case of Starbucks, those risks are more than compensated by the company's potential.

If you're an investor who prefers returns to rhetoric, you'll want to read The Motley Fool's new free report "5 Dividend Myths... Busted!" In it, you'll learn which stocks provide premium growth and whether bigger dividends are better. Click here to keep reading.


Robert Baillieul has no position in any stocks mentioned. The Motley Fool recommends 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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