Starbucks Corporation’s Stock Analysis

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Background Of The Company

Starbucks Corporation was founded in early 1970s in Washington DC, America. The main business of the company is brewing and selling coffee together with hot drinks and also cold drinks. The company also sells sandwiches, salads and hot dogs among other snack foods. Since its incorporation, the company has grown and expanded. It now has more than 17,000 stores and it operates in more than 50 countries all over the world. The company trades it’s shares on London Stock Exchange. The company has been accused of bad business ethic in labor activities, environmental responsibility and non-adherence to fair competitive practices. The company opened its first stores outside America in 1996 (Starbucks Corporation, 2011).

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Due to its rapid expansion in the 1990s, the company has become a viable investment for most business people. However, the company closed some stores in 2008 which makes it necessary to conduct a good analysis on the viability of the business. The company closed 600 stores in the United States of America due poor performance in 2008. Additional stores were closed in 2009 which made more people to lose their jobs. The company made its initial public offering (IPO) in 1992 and it was successful owing to its good performance over time. The price for its stock was $ 5.50 and it has risen to $ 58 in 2010 (Starbucks Corporation, 2011).

Analysis of Return On Equity

Return on equity is a measure of an organization’s profitability in relation to the investment made by the investors. Equity refers to common stock, share premium and retained profits. Generally, equity is any stake that the owners of a business have in the business. The main aim of a business is to maximize the shareholder value therefore return on equity is of high importance to both existing and potential investors. According to Bodie, Kane and Marcus (2006), “return on equity is calculated by dividing net income with the total equity” (p.23). The average return on equity of Starbucks Company is 19%. The industry average of return on equity is 13%. Therefore, the return on equity for Starbucks Corporation is higher than the return on equity for the other companies in the industry. The company is therefore more profitable than the others.

The Company’s Projected Future Growth Rate of Earnings

Projection of growth in the rate of earnings is an important part of investment analysis and portfolio management. This projection helps an investor to know the expected future earnings consequently make the right decision. A projection of the future growth in earnings is done be evaluation the business environment, competition of the industry and then the internal factors of the business. This provides one with an approximation of a realistic growth rate in the future (Renganatham, 2004).

When forecasting the future growth rate in earning for Starbucks Company, it is important to note that the business of the company experiences seasonal fluctuations. Higher sales revenue and profit is recognized during the holiday seasons. The products offered by the company are price elastic due to availability of close substitutes. There is competition in the coffee industry coming from three main competitors in the America who are Caribou coffee, Diedrich coffee and Dunkin brands. There are also other competitors in the other parts of the world.

The consumption of coffee in the America and other parts of the world is rising steadily and this trend is estimated to continue in the future. There is also an increase in disposable income and improvement of general living conditions in Asia and other parts of the world hence coffee consumption is likely to increase in those particular countries. There is a big threat to the performance of the company due to the coffee crisis in the global arena. This coffee crisis has been brought by overproduction of coffee, reduction of prices of coffee and neglecting of coffee farms among other things.

The company’s products are highly differentiated and the company has stores in most parts of the world. The company is also a market leader in the industry and it has experience in the coffee industry unlike its competitors. This puts it in a better position to make profits in the future. The company also has a strong financial base. The company has some weaknesses which could affect the performance of the business in the future. These weaknesses include high costs of production, poor organization structure and poor cross functional management (Lee, 2002).

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After considering the macro environment, competition in the industry, strengths and weaknesses of the company, the logical conclusion is that the company will attain a growth rate of 9% in the future. This is forecasted for the next three years. This has been arrived after consideration of opportunities that exist together with threats, strengths and weaknesses. This estimation is thus realistic.

Analysis of Required Rate of Return using CAPM

This is an effective tool in making a projection of the expected return from a common stock. This model states that the future price of a stock is dependent on time value of money and the risk of the stock. In this mode, “time value of money is represented by the risk free rate of investment” (Bodie, Kane & Marcus 2006, p.25).

The CAPM formula is as follows:

Expected rate of return (r) = rf + β(rm-rf) (Bodie, Kane & Marcus 2006)

The risk free rate (rf) is the rate of return expected on a risk free asset such as government security while beta (β) is a measure of the movement of the stock in relation to changes in the market conditions. The market return (rm) is the rate of return on a similar stock in the market. According to Yahoo finance, the risk free rate of a 5 year US treasury bill is 1.48% and the beta for the Starbuck’s stock is 1.26. Return on stocks in the market is 9.23% (Yahoo Finance, 2011). The return on the Starbuck’s stock using CAPM is:

Return on Starbuck’s stock (r) = rf + β (rm-rf)

= 1.48 = 1.26 (9.23 – 1.26) = 11.52%

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The investors of Starbucks Corporation should expect a return of 11.52% in the future according to Capital Assets Pricing Model (CAPM).

Company’s Intrinsic Value Using the Discount Valuation Techniques

The theoretical value of the stock of Starbuck s Corporation can also be determined using the discounted cash flow methods. The concept behind discounted valuation methods is that a stock is worth the present value of future cash flows expected from the stock. Cash flows associated with a stock are mainly dividends. To calculate the intrinsic value of stock using discounted cash flow method, the growth rate in earnings per share is estimated. The second step involves calculation of the expected earnings per share in the future followed by calculation of average Price earnings ratio. The annual rate of return is decided and the earnings per share discounted using the required rate of return to give the intrinsic value.

The formula for calculation of the intrinsic value of Starbuck’s stock is as follows:

Intrinsic price (p) = D {(1+g)/(k – g)} (Bodie, Kane & Marcus 2006)

D is the dividend paid lastly by the company which is $ 0.52 while g is the projected future growth rate in earnings. K is the required rate of return. According to the earlier sections of this paper, the projected growth in earnings for the company is 9% and the required rate of return using the CAPM model is 11.52.

Therefore, the intrinsic value of Starbucks’ stock = 0.52 {(1+0.09)/(0.1152 – 0.09)} = $ 22.58

Conclusion

When making a decision on whether to invest in a stock or not, it is good to conduct a thorough analysis of the stock you are interested in. This is to ensure that one makes the correct decision. The evaluation of the stock for investment entails conducting an analysis on the return on equity of the company, making a projection in future growth of earnings of the stock, estimating the required rate of return using the CAPM model and then estimating the value of the stock using the discounted cash flow methods. The essence of the whole process is to ensure that an investor makes informed decision regarding a stock. This process takes into consideration the market forces, competition and internal factors of an organization. The analysis of the Starbucks Corporation stock has resulted to an intrinsic value of $ 22.58. The market value of the share is $ 40.32 therefore the stock is over valued. An investor should thus retain the stock or purchase it since it will result to more profits in the future (Lee, 2002).

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References

Bodie, Z., Kane, A. & Marcus, A. (2006). Essentials of investments. New York, NY: McGraw-Hill Education.

Lee, C. (2002). Advances in investment analysis and portfolio management. 9 Edn. Oxford: Elsevier.

Renganatham, M. (2004). Investment analysis and portfolio management. New Delhi, ND: Pearson Education India.

Starbucks Company. (2011). Starbucks Company. Web.

Yahoo Finance. (2011). Starbucks Corporation (SBUX). Web.

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