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.
SBUX’s PE multiple
Better-than-expected fiscal 4Q16 earnings, menu innovations with the introduction of holiday beverages and festive food items, and Donald Trump’s election victory have increased investors’ confidence, boosting Starbucks’s stock price and PE multiple. As of January 13, 2017, Starbucks was trading at PE multiple of 25.9x.
The business model adopted by Starbucks allows the company to expand aggressively, while its menu innovations and enhanced customer experience have helped the company maintain high same-store sales growth. These factors have allowed the company to trade at a higher valuation multiple than peers. In comparison, peers Dunkin’ Brands (DNKN), Domino’s Pizza (DPZ), and McDonald’s (MCD) were trading at 21.5x, 32.6x, and 19.7x, respectively, on January 13, 2017.
For the next four quarters, analysts expect the company to post EPS growth of 13.6%. 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.
You can mitigate these company-specific risks by investing in the Consumer Discretionary Select Sector SPDR ETF (XLY), which has ~9% of its holdings in restaurant and travel companies. Next, we’ll look at what analysts recommend for Starbucks ahead of its fiscal 1Q17 earnings release.