It's been some time since I penned an article. Like many young investors, I've been reading, learning (what a curve huh?!), watching the markets, putting my assumptions under a microscope and navigating a series of value or growth identity crises. I didn't want to return to the pages of Seeking Alpha until I had something new to offer the discussion. I also felt it was important to start taking a stake in every stock I recommend; moving forward, rest assured my money is where my mouth is.
I value Peter Lynch for what he taught me about valuation and Warren Buffett for what he taught me about seeking out great businesses, but I'll no longer refer to my mentors in articles. I favor an open-minded approach that draws on many schools of thought as well as my own experience. I've come to accept that fact that I can't predict what Mr. Market will do next month or next year. I just want to identify great companies with profitable business models and in the coming weeks and months, I will recommend stocks for two different investor types, track investment returns via Morningstar and publish updates as needed.
While I've shied away from growth investing in the past, I have recently begun investing in growth stocks in a taxable account. I don't buy super-speculative biotechs or anything of the sort. These are companies with solid fundamentals (mostly mid-caps) growing north of 20% per annum and trading at a reasonable multiple. I'll call this Fiver's Growth Portfolio. Check back for my first pick coming soon.
In my Roth IRA, I am accumulating for retirement. This account is dedicated to companies with sustainable competitive advantages and secular growth stories. Stocks I could potentially hold until I retire in 20 years. Most of them pay dividends which I will re-invest. Important to note, I will not restrict myself to companies which have consistently raised their dividend for a certain number of years. While I appreciate this philosophy, all great dividend stories start somewhere. My first pick for Fiver's Accumulator Portfolio, Starbucks (NASDAQ:SBUX), is a perfect example.
I believe we'll look back in 20 years and see Starbucks listed alongside iconic American brands like Coke, Pepsi and McDonald's. Some might say it's already there but more importantly, I believe this status will be reflected in its market cap. I consider myself a cynical consumer yet I'm consistently amazed by the friendly service at every Starbucks I visit and the incredible amount of time commuters will wait in line for their favorite drink. The company is truly succeeding in its vision of creating a second home environment. Consider me a fan of the brand; this is a stock I want to own for a very long time.
A strong and rising earnings trend often indicates a business benefiting from a consumer monopoly and profit-minded management.
Starbucks Earnings per Share
While clearly in an uptrend, Starbucks earnings were clearly dented during the 2008 financial crisis. I believe this has as much to do with its over-aggressive domestic growth strategy as it does with entrenched consumers. I'm encouraged that consumers continue to spend at Starbucks even as employment languishes.
Starbucks long term debt of $550 million is a fraction of its $5 billion in shareholder equity. Free cash flow of $1.5 billion in the last 12 months alone could pay off the debt entirely with room to spare.
Return on Equity
Companies that consistently deliver high returns on shareholder equity are true wealth creators. Average businesses typically offer a 12% return on equity while great businesses return over 15%.
Starbucks Return on Equity
Starbucks average return on equity over a 10 year period is a stellar 22.4%.
Whether it's via share buybacks or new investment in the core business, I want to own companies that are free to reinvest retained earnings at high rates of return. What I don't want to see is high research and development costs or capital expenditures in the form of plant and equipment replacement. In Starbucks case, there are no R&D costs and even though capital expenditures are high compared to net earnings (67% over the trailing 12 months), cap ex is attributable to ongoing international expansion and free cash flow is positive.
Current yield on Starbucks shares is 1.23%. The dividend was initiated in 2010 at $.23 and has tripled to $.76. Payout ratio is more than reasonable at 38%. This is a company in the very early stages of growing its dividend substantially. Don't wait until it's a Dividend Aristocrat. Buy now and accumulate.
Starbucks current P/E is 31. Looking at its 5-year average P/E of 30, Starbucks is slightly overvalued based on its historic valuation. It's also approaching its 52 week high of $62 a share. I would wait for a breakout over this high or a pullback to support in the low 50's to initiate a new position. At around $50, Starbucks would be trading at a fair multiple for its current growth rate.
I realize at some point, the market will stop valuing Starbucks as a growth stock and multiple compression will ensue. This is all part of the journey when you commit for the long haul.