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Chart in Focus: Starbucks’s Valuations

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Valuation multiples

Investors may want to look at valuation multiples when deciding whether to buy or sell stocks. Valuation multiples are driven by perceived growth, risks and uncertainties, and investors’ willingness to pay.

Analysts use various multiples to evaluate stocks. In this article, we’ll use the PE (price-to-earnings) multiple due to its high visibility in Starbucks’s (SBUX) earnings. The forward PE multiple is calculated by dividing a stock’s current price by its forecast EPS (earnings per share) for the next 12 months.

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Starbucks’s PE multiple

Starbucks’s (SBUX) fiscal 1Q17 same-store sales growth (or SSSG) was its lowest since 2009. This made investors skeptical of its future earnings, leading to a fall in Starbucks stock and its forward PE multiple. On January 27, 2017, Starbucks was trading at 25.1x, down from 26.2x before the announcement of Starbucks’s fiscal 1Q17 earnings.

Starbucks’s business model has allowed the company to expand aggressively, while menu innovations and an enhanced customer experience helped the company maintain high same-store sales growth. These factors have allowed the company to trade at a higher valuation multiple than its peers.

On January 27, 2017, Starbucks’s peers Dunkin’ Brands (DNKN), Domino’s Pizza (DPZ), and McDonald’s (MCD) traded at 21.3x, 33.6x, and 19.8x, respectively.

Growth prospects

To improve its SSSG, Starbucks has been focusing on the enhancement of its customer experience, menu innovations, and one-to-one personalized selling. All these initiatives are expected to increase Starbucks’s expenses. If these initiatives fail to produce the expected SSSG, the increased expenses could put pressure on Starbucks’s margins, thus lowering its earnings.

Analysts expect Starbucks to post EPS of $2.20 in the next four quarters, which represents a growth of 12.8% from $1.96 in the corresponding quarters of the previous year. Starbucks’s current share price may have already factored in this EPS growth. If the company’s results are lower, its stock could face selling pressure, bringing its PE multiple down.

In the final part of this series, we’ll look at what analysts are recommending for Starbucks after its fiscal 1Q17 earnings.

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