These Three Companies are Worth Researching

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

You may hold a desire to invest in the stock market, but you may be wondering, “Where do I begin?” The answer is simple--look no further than the companies responsible for bringing you your cup of coffee. Of course, you can’t just invest in a coffee company just because you like the taste of your brew. The importance of research into the company’s fundamentals and what drives it can’t be overemphasized.

Qualities of a strong coffee company

Three major publicly traded companies focus directly on conveniently bringing you coffee during your rushed morning routine: Starbucks (NASDAQ: SBUX), Dunkin’ Brands Group (NASDAQ: DNKN), and Green Mountain Coffee Roasters (NASDAQ: GMCR).

Each of these companies displays the following three qualities:

1. Brand recognition

2. Product quality and innovation

3. Strategies to strengthen and expand their brand

A name synonymous with quality

With nearly 19,000 stores worldwide, the Starbucks name equates to quality coffee and cappuccino in the mind of the collective consumer. Its emphasis on product quality gives consumers reason to pay extra for its products without guilt.

Starbucks innovation in being innovative (emphasis mine) represents an interesting aspect of this company. For example, Starbucks owns a website where people can submit ideas of all sorts, from new product ideas to customer service experience and community involvement. It also allows for online community discussion.

Starbucks employs various strategies to strengthen and expand brand recognition. For example in its last shareholders meeting, the company introduced a “cross-channel, multi-brand loyalty program” where the customer can purchase its various products across different channels such as grocery stores for points redeemable for free products at Starbucks stores.

Another example includes Starbucks expansion of its long-term strategic partnership with Green Mountain Coffee Roasters. Starbucks will allow Green Mountain Coffee to make K-Cups and Vue Packs with Starbucks labeling.

Starbucks’ efforts to build and maintain brand recognition as well as product innovation resulted in excellent fundamental strength and superior share price appreciation. Starbucks saw its revenue increase 14% in 2012, and operating cash flow increased 9%. However, increased investment spending caused free cash flow to decline 25%.

Starbucks maintains an excellent balance sheet. Cash and investments comprise 42% of stockholder’s equity, while long-term debt to equity ratio stands at a very low 11%. In 2012, Starbucks paid out 57% of its free cash flow in dividends. It currently pays $0.84 per share per year and yields 1.3% as of this writing.

Look for the company to capitalize on the healthy lifestyles trends as it incorporates and expands its Teavana brand. In addition, the company stills possesses a relatively small number of stores in China and emerging markets such as those in Africa, which means it still has room for expansion.

Donuts, coffee, and ice cream

Dunkin’ Brands Group owns not one but two iconic brands: Dunkin’ Donuts and Baskin Robbins. Dunkin Donuts sells all kinds of breakfast food to the hurried morning time commuter, from coffee, donuts, breakfast burritos and bagels. Baskin Robbins, an old brand name that goes back decades, sells high quality ice cream and cakes.

Dunkin Brands launched 30 new products in 2012. Examples include K-Cups with Green Mountain Coffee Roasters, a new red velvet donut and an Oreo Coolatta.

One of Dunkin Brands’ greatest strength lies behind its “asset light model.” You may ask “Why would I want to own shares in an asset light company?” This means nearly 100% franchised ownership. The franchisee performs all of the heavy lifting when it comes to overhead. This also allows Dunkin Brands to focus on product innovation, which keeps customers coming.

This asset light model shows its strength in the company’s free cash flow margins. Dunkin Brands’ free cash flow is an impressive 20%, versus 7% for Starbucks and 2% for Green Mountain Coffee Roasters as of the end of 2012. Dunkin Brands also sports the highest return on equity at 31%, versus 27% for Starbucks and 16% for Green Mountain Coffee.

Last year, Dunkin Brands’ revenue increased 5%, while free cash flow declined 8% due to working capital adjustments and timing. In 2012, Dunkin Brands paid out 53% of its free cash flow. Currently the company pays $0.76 per share per year in dividends, yielding 1.8%.

The balance sheet leaves much to be desired. Cash and investments as a percentage of stockholder’s equity calculate to about 72% as of the end of 2012. However, it’s debt to equity stands at a staggering 521%. Its operating income exceeds interest expenses by only 3 times.

You need to look out for the company’s divided focus between Dunkin Donuts and Baskin Robbins. In the future, look for Dunkin’ Donuts to flourish both in domestic markets and international markets. However, in the domestic markets Baskin Robbins continues to struggle, with same store sales declining 4% in its most recent quarter. In the international markets, Baskin Robbins flourished, with same stores sales increasing 4%.

Brand in a cup

The little “K-Cups” that go into the sleekly designed Keurig coffee maker gives Green Mountain Coffee a form of brand recognition. Every successful company possesses a trademark design, and its K-Cups and coffee makers represent just that.

Green Mountain Coffee Roasters introduces new models of its coffee makers to keep customers’ interest. In addition, it partners with various companies to allow them to put their products into its K-Cups, allowing for product diversity and increasing brand visibility for Green Mountain Coffee and its partners.

Green Mountain Coffee Roasters certainly resides in a steep growth trajectory. Revenue increased 46% in 2012, and free cash flow swung from a negative $283 million to a positive $77 million last year.

That said, Green Mountain Coffee’s small cash position leaves me a little uncomfortable at 3% of stockholder’s equity. In addition, it’s long-term debt to equity stands at 21%.

Conclusion

In summary, all three of these companies enjoy brand recognition, sell high quality products, seek to improve their line of products and work to maintain and expand branding opportunities. The balance sheets of Dunkin Brands and Green Mountain Coffee Roasters can stand some improvement. However, these companies deserve more of your research time.

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William Bias has no position in any stocks mentioned. 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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