Whether we consciously know it or not, subconsciously we all pretty much understand that “wants” are more powerful than “needs.” Starbucks (NASDAQ:SBUX) verified that idea again last quarter. Nobody “needs” a $3 cafe latte — especially in an economic environment as weak as this one. Enough people wanted a $3 cafe latte in the third quarter, however, to pump up the coffee shop’s year-over-year earnings by nearly 30%.
The 37 cents per share Starbucks earned in its fiscal fourth quarter wasn’t a record — that honor belongs to the period ending very early this year, when it pulled in 45 cents. The most recent quarter’s income was tied for the best fiscal fourth quarter ever, though, which happened to be last year’s Q4. More important, that 37 cents per share in income earned last quarter tops off the company’s best year ever — it earned a whopping $1.52 per share in 2011.
So much for the notion that consumers are just too timid and cash-strapped in this “new normal” market to frivolously waste cash on gourmet goods. (Odds are good these same “broke” consumers enjoyed their coffee while tapping into their local Starbucks’ Wi-Fi via their new iPads, which they also allegedly can’t afford.)
And yes, the market loved the news. Traders sent the stock higher by 7% on Friday, taking it to new 52-week highs in the process. SBUX now trades at nearly 29 times its trailing earnings, and a frothy 24 times its projected (2012) income.
It’s a value-oriented analyst nightmare, but this is a case where the market might know better than the pros that Starbucks shares can justify these lofty prices.
One Thing’s for Sure: Coffee is Hot!
Were it just Starbucks doing well, or just its one-day success, the market’s bullish interest could understandably be questioned. It’s not just Starbucks, though.
Close competitor Caribou Coffee Company (NASDAQ:CBOU) is on the same roll. Through its 534 coffeehouses spaced out over much of the nation, it’s been growing its top and bottom line for two-and-a-half years now after swinging to a profit in late 2008. The prior quarter’s $80 million top line was a best-ever result, and the $4.4 million bottom line also was a best-ever, at least in terms of operating profit. Though its typical net profit margin of 4.2% is dwarfed by Starbucks’ average 10.1% margins, CBOU shares also are priced more palatably at 8.8 times their trailing earnings.
And therein lies the rub — do you make a coffee play with the undervalued underdog that’s posted surprisingly strong numbers, or do you stick with the overpriced industry king that’s all but impossible to unseat?
Let’s put it like this: Price-conscious consumers don’t necessarily want to maintain that attitude when it comes to picking stocks.
The Stock & the Coffee — Overpriced, But Still in Demand
If $3 for a cup of coffee feels horrifyingly expensive to you, odds are good that a trailing P/E of 29 also feels way too bloated. The market has a funny way of tolerating — and even rewarding — certain brand names like Starbucks, though. You’ll find examples of this in every industry.
Case in point? Amazon (NASDAQ:AMZN). This e-tailer’s stock has soared from $40 in 2004 to more than $200 now, and not once during that time did shares trade at less 90 times its trailing income. Toe expensive? Sure. But was it still a profitable stock? You bet.
While Starbucks’ valuation isn’t quite to that extreme, the point is still clear: Investors don’t always have a problem paying up (and up and up and up) when the story is really good, or when they’re customers of the company. In fact, its shares haven’t traded below a P/E of 20 since 2002, yet the stock’s worth four times what it was worth then.
Yes, these buyers may grumble the whole time they’re buying in, but SBUX is one of those names the market secretly loves to love and doesn’t mind paying a premium for. Last quarter’s numbers simply put a little more sugar in the cup.
As of this writing, James Brumley did not own a position in any of the aforementioned stocks.
