We went on record in Fortune that investors should short Starbucks (SBUX) on 11/6/2006 when the stock was close to $38 per share. The stock did not look attractive to us until two years later when it was under $8, and that for only about three days (11/18 – 11/20/08). Ever since we have had a Neutral or Dangerous Rating on the stock.
Don’t get me wrong, Starbucks has performed a rather remarkable turnaround in profits as it switched from an aggressive growth strategy to a retrenchment strategy as we suggested it should do on CNBC on 11/16/2006. And I believe the change in logo is a smart move, as it emphasizes Starbucks' intelligent shift from focusing on selling a commodity (e.g. coffee and the like) to selling a brand, which offers higher margins.
But that shift has already largely take place. There is not much more room to grow before larger, more established players in the consumer packaged-food space take notice. And those companies with comparable brand power and superior distribution put a cap on Starbucks' growth opportunities.
The bottom line: Starbucks is a good company but not a good stock. There is simply not that much profit opportunity in a coffee shop, no matter how glamorous it makes the coffee-drinking experience.
The valuation is already rich and expectations are high. In other words, the market and investors have already set a very high bar for future performance. Specifically, the current stock price ($32.35) implies the company will grow profits at a 10% compounded annual growth rate ((CAGR)) for 15 years. In addition, the company is not as profitable as people think, as it carries about $3.6bn in off-balance sheet debt — equal to about 80% of the company’s reported net assets.
All the details are in our Company Valuation Report on SBUX, available for free here (PDF).