Decades ago, investment manager Peter Lynch put forth the idea of simply buying stocks that make the products you love and use regularly. That idea appeals to many people.
It’s never a bad thing to "invest in what you know," but that concept offers no clues about the relative value of a company’s shares versus its market price. Starbucks (SBUX, Financial) reported nice numbers for its fiscal second quarter (ended March 31) after the close on Thursday afternoon.
Shares that peaked at $64 on Oct. 30, 2015, however, fell to close at $58.22 in the after-hours session. Could that almost six-month, not insignificant decline have been predicted? Is Starbucks cheap now that it’s fallen?
A look at the firm’s long-term data says “Yes” to the first question and “No” to the second. High-quality Starbucks averaged a 25.8x multiple during the entire nine-year period from fiscal year 2007 through fiscal year 2015 (fiscal years end on the Sunday nearest Sept. 30).
Each of the four most significant tops (red-starred on the chart) came at higher than typical P/Es. The six “best buying opportunities” (green-starred) all occurred at lower than average valuations.
Last October’s yet to be repeated pinnacle represented Starbucks’ highest P/E since the bubbly market environment early in 2007. Buy-and-hold types who loved the stock back then, because they craved the coffee, were paying more than 41 times 2007’s earnings. Those with the courage, stupidity or stubbornness to hang in there right through 2008's crash and beyond ended up suffering greater than 82% drawdowns at that year's most extreme nadir.
Patient types eventually made money but ended up waiting more than four years just getting even. That gave a new meaning to being burned by overly hot coffee!
Interim peaks during April 2012 and November 2013, led to a 6½-month, 30.6% pullback and a 16.1%, nine-week decline. The selloff from last year’s top, at 40.5x this year’s estimate, should have been expected.
Starbucks dipped back to near the $54 mark during the February panic before rebounding, too much it seems, along with many other large-cap stocks that have also been looking quite pricey.
The public is often oblivious to “proper valuations” as research analysts love, love, love high momentum stocks. Good charts often blind them to the risk of regression to the mean even though they have full access to historical data.
Standard and Poor's April 16 rating on Starbucks was a 4-star buy (with the shares at $60.51). It noted the company’s trailing P/E of 37.1x and its higher-than-normal multiple on its own fiscal year 2016 estimate.
S&P’s computer-generated quantitative "fair value" weighed in at just $47.60, almost $13 per share below its quote back then. Why, then, did the analyst rate Starbucks as a buy?
Starbucks is well-managed and solidly financed. Long-term growth will likely eventually push the stock price much higher. Why pay up, though, to own a stock that has presented so many chances to establish positions at much more reasonable valuations?
A normalized 25.8 times the company’s fiscal year 2017 estimate of $2.20 per share would only support a 15-month goal a tad south of the stock’s current price, even after the post-earnings report damage.
Enjoy Starbucks' coffee, tea and pastries, but pass on Starbucks' shares until the valuation becomes more enticing.
Disclosure: No position in Starbucks.
