Starbucks (SBUX, Financial) has been one of the best-performing stocks over the last few decades and I have been bullish on it for quite some time. The company’s business model is very strong, and the company’s prospects are bright, too, as it has lots of room to expand. Despite the massive growth potential, Starbucks is overvalued, and investors should wait for a better entry point before buying the stock.
Great company, bad investment
Innovations and brand experience have always been Starbucks’ main strengths and have been the primary factors propelling the company’s growth over the years. For instance, Starbucks’ latest innovation was its mobile app that allowed customers to place their orders before arriving at the store. The app was greatly successful as it reduced the waiting time for customers and improved the brand experience.
Due to the success of the app, Starbucks witnessed robust comps growth over the last few quarters. The company is growing comps at a tremendous pace; however, it will eventually slow down. Investors have priced in years of growth in Starbucks’ current share price and a minor hiccup in the future can push the stock a lot lower.
Starbucks, despite being down 9% year to date, is trading at over 42x trailing earnings. Granted the company has lots of room to expand, but investors will focus more on the company’s comps, which will slow down considerably in the coming months. Like every company, Starbucks will soon run out of innovations, albeit temporarily, and comps will drop in the coming quarters.
Given Starbucks’ current valuation, a minor decline in comps can send the stock a lot lower, which is why I think investors should avoid it.
Market turmoil
As of now, 2016 has been a pretty bad year for momentum and growth stocks. With a trailing P/E of over 42, Starbucks is clearly trading at the valuation of a growth stock. The stock is priced so high only because of the anticipation of strong growth. But I am fairly confident that it will fall to a more conservative valuation amid the current market correction.
A high P/E growth stock is certainly not what investors should be buying in the current market, which is why I think Starbucks is a sell for now.
Conclusion
Given the bearish market sentiment, I think investors should avoid, if not short, high P/E growth and momentum stocks. Starbucks, with a P/E of over 42, is certainly not a stock that investors would want to buy in this situation. Investors should sell Starbucks and wait for a better entry point; the stock can fall below $50 in the coming months.
