Global coffeehouse chain Starbucks (SBUX, Financial) may have got some investors confused – whether to put in money into the stock or not. While analysts and industry experts are all over the stock and believe it has great upside potential, a segment of investors who believe strongly in investing after considering the margin of safety (MoS) of the stock are thinking twice before making the move. Through this report I will be discussing about Starbuck’s intrinsic value, the absence of margin of safety, and yet what makes it a good buy.
Intrinsic Value and Margin of Safety
Several investors, including the legendary Warren Buffett (Trades, Portfolio), considers margin of safety to be a crucial parameter while selecting a stock for the portfolio. While it’s difficult to say what the benchmark MoS figure should be, since it varies from one investor to another and depends upon the risk appetite of the investor, everyone will agree a positive MoS figure is definitely encouraging. MoS is nothing but the difference between the market price of the stock and the intrinsic value (or fair value) of the stock, expressed as a percentage on the intrinsic value, and intrinsic value means the present value of sum total of all the income that can be generate from a stock in its lifetime.
As of this writing Starbucks shares are trading at $48.17 (this is after the recent 2:1 stock split), up from previous close of $47.96, and much close to its 52-week high of $49.60. For the purpose of calculating the intrinsic value, I used Guru Focus’ DCF calculator. The following image shows the result of the calculation. Intrinsic value of Starbucks stock came to $31.35, suggesting the stock is currently 54% overvalued, and hence, several investors are giving it a second thought.
Source: Guru Focus
Is it worth your money?
Despite being overvalued and having no margin of safety, Starbucks actually offers a great opportunity to benefit from the stock. The point to note is, intrinsic value is the sum total of the present value of all possible earnings from the stock. This has nothing to do with the market price of the stock. A stock’s market price is a result of the dynamics of demand and willingness of the market to pay for the stock. So, intrinsic value being lower than market value isn’t necessarily a warning sign for investors.
Compared to its fair value surely the stock is overvalued, but still it has great upside potential now on also. 12 out of 26 Yahoo Finance analysts have a ‘strong buy’ rating on the stock, seven have ‘buy’ rating and six have ‘hold’ rating – this says a lot! For Starbucks analysts have a high target of $56.00, 16.6% higher than its current market price. And why shouldn’t the expectations be such. The coffee expert is expected to increase its store count in international markets and improve its comp sales. Another factor that can boost initiating of expanding the position in Starbucks right now is the increasing demand for its shares on the back of the recent 2:1 stock split. Because of this the shares of the company has become more affordable and this shall benefit the stock price going forward. So, the bottom line is, investors shouldn’t be worried about the nil MoS. The stock has good upside potential and can prove to be a worth addition to the portfolio.
