Valuation multiple

Due to the high visibility in Starbucks’s (SBUX) earnings, we have opted to look at the forward PE (price-to-earnings) multiple. The forward PE multiple is calculated by dividing the company’s stock price from analysts’ earnings estimates for the next four quarters.

How Does Starbucks’s Valuation Multiple Compare to Peers?

Starbucks’s forward PE multiple

Starbucks’s expansion plans in China and the expectation of a decline in effective tax rate due to the enactment of tax reforms appear to have increased investor confidence, leading to a rise in Starbucks’s stock price and its forward PE multiple. As of January 19, 2018, Starbucks was trading at a forward PE multiple of 24.6x compared to 23.1x before the announcement of fiscal 4Q17 earnings. On the same day, McDonald’s (MCD), Dunkin’ Brands (DNKN), and Domino’s Pizza (DPZ) were trading at forward PE multiples of 24.4x, 24.0x, and 27.7x, respectively.

From the above graph, we can see that the gap between Starbucks’s valuation multiple and its peers’ median has fallen. The lower-than-expected earnings in all four quarters of fiscal 2017 led the company’s valuation multiple to decline.

Growth prospects

To drive its same-store sales growth, Starbucks has been focusing on menu innovations, opening roasteries and Starbucks Reserves, and the implementation of digital advancements to enhance customers’ experience. These initiatives are expected to increase Starbucks’s expenses. If these initiatives fail to generate expected sales, the increased expenditure could put pressure on Starbucks’s earnings.

For the next four quarters, analysts are expecting Starbucks to post EPS growth of 15.0%, which could have been cooked into the company’s current stock price. If the company fails to post earnings in line with analysts’ expectations, then the selling pressure could bring the company’s stock price and its valuation multiple down.

Next, we will look at analysts’ recommendations.

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