Starbucks (SBUX) has delivered a volatile year to shareholders. At one point this year, investors were up over 34% on their shares. In late April however, the stock made an abrupt turn and after a subsequent 23% decline, many investors are sitting at breakeven for the year. Through this report, I present that the stock has been in a bubble for several years and further downside is possible.
The chart below shows the growth of Starbucks since its post-crisis lows in 2009.
Following the market bottom in 2009, Starbucks rallied over 600% to its peak in 2012. This incredible rally displayed a climax between the beginning of 2012 and April of 2012 by increasing in price over 34% in those months alone. With this type of aggressive growth, the astute investor must surely be aware that the share price of Starbucks has strongly exhibited the traits of a security in a bubble.
The first form of evidence we will rely on to help us determine if the Starbucks bubble has "popped", is a study of the NASDAQ during the end of the Dot-com bubble. As many are aware, the Dot-com bubble was a time in which technology stocks were aggressively valued and share prices exponentially increased for many companies. The market continued this aggressive growth for several years before a dramatic conclusion to the rally in the year 2000.
One of the key elements we can rely on to determine if a bubble has popped or a trend has ended is the exponential growth at the end of the trend. The period of exponential growth represents a time in which investors throw caution to the wind and purchase shares regardless of the price. This surrender to elated emotions is almost always punctuated by a collapse in share price as investors run out of capital to invest and long-time holders decide to sell out in size. Notice in the above chart showing the NASDAQ performance that during the last few months of the rally, prices dramatically increased at an exponential rate. In fact, between 1999 and early 2000, the index gained more than the previous 8 years combined! Immediately following these gains, the market collapsed and erased the previous few years of gains in a few months.
In the same way, Starbucks has clearly demonstrated a bubble in share price. During final 3 months of the current rally, Starbucks exponentially increased in share price. This gain was punctuated by a rapid collapse which erased all of the gains earned during the exponential growth. It is my belief that the bubble has not quite popped and further downside is entirely possible.
Growth and Value
Despite the chart clearly showing a stock in correction, I believe that stronger proof of stock mispricing is found on the balance sheet. An item that warrants examination is revenue growth. The idea behind studying revenue growth is that it allows us to see not only if a company is growing in their earnings, but also the rate at which they are growing. The chart below shows the revenue growth for Starbucks for the past 9 years.
There is no mistaking the fact that Starbucks is a good company. During the past 9 years, it has only had 4 quarters in which it had a negative revenue growth. In other words, revenues have been growing in 32 of the previous 36 quarters. With such an excellent growth history, it is very easy to understand why individuals have been interested in the stock. However, I argue that even though the company is strong, there has been a fundamental decoupling of the true value of the company and the value that investors attach to it.
In order to put this strong revenue growth into perspective, we should examine it in light of the value of the company. The reasoning for this examination is that as revenues are growing, then market cap should be growing as well. If revenues are not growing, or growing at a slower rate, then market cap should not be growing or growing at a slower rate as well. This relationship can be seen in the below chart.
It is very insightful to examine the full history of this data. Notice that up until mid-2010, this theory was sound. As revenue growth increased, market cap increased in relative proportion and the opposite was true for decreases in revenue growth. In mid-2010, something very noteworthy occurred - revenue growth did not increase, however market cap doubled. In other words, even though the company was not displaying increasingly strong revenues, the value of the firm went up over 100%. It is during this time period, that I believe the stock price for Starbucks entered a bubble.
Make no mistake that Starbucks is a great company. It has solidly-growing revenues, a large and successful business model, and millions of loyal customers. My qualm isn't with the company, it's with the share price. Not only has the share price exhibited the traits of a bubble, but the value of the company has strongly detached from the fundamentals of the firm. This represents a great shorting opportunity. Ever since revenue growth stabled in mid-2010, the firm has doubled in price. It is where this decoupling began that we should set our profit target. I believe that even though the market cap of Starbucks is $36 billion, it is only worth $20 billion, since this is where the decoupling of value and fundamentals started. This said, my profit target on the short trade is at this location. In order for the value to get here, the share price must fall 44% to $26 per share. Technically speaking, significant support could form around $30 per share. This said, I believe a healthy target is anywhere between these two levels. In order to protect ourselves in case the share price continues traveling upwards, I believe a good stop on the trade is around $55 - an area in which prices consolidated immediately following the peak of the run-up in share price.