Why I invested in Starbucks

• Pencils Fund Purchase: Starbucks (SBUX)
• Purchase Price: $30.65
• Shares Purchased: 6
• Commission: $6.95

Starbucks' business probably doesn't need to be explained, but for those of you who somehow don't know: Starbucks operates as a specialty retailer, specifically coffee, along with some other drinks, but coffee is the key product. Starbucks was founded in 1985, and is now a signature name when it comes to coffee. Starbucks engages in the purchase, roasting, and selling of the coffee beans.

Financials
Some quick numbers for Starbucks (Data from Yahoo! Finance):

• Market Cap 23.31B
• Shares Outstanding 767.49M
• Employ­ees 115,000
• Qtrly Rev Growth (yoy) 24.20%
• Revenue (ttm) 7.08B
• Gross Margin (ttm) 59.50%
• Return on Assets (ttm) 14.79%
• Return on Equity (ttm) 21.94%
• EBITDA (ttm) 1.26B
• Oper Margins (ttm) 11.17%
• Net Income (ttm) 550.80M
• Cash (mrq) 445.45M
• Debt (mrq) 98.25M
• EPS (ttm) 0.69
• P/E (ttm) 44.02
• P/S (ttm) 3.32
• % Held by Insiders 2.15%
• % Held by Institutions 68.20%

As of July 30, Starbucks had 11,946 stores in 37 countries. For the sake of time and length, I'll pass on a previous post I did here at Blogging Stocks, which explains why Starbucks is down and its future plans.

Competition
The main competition I see are the local Mom & Pop diners, who will take a small portion of Starbucks revenue. But, I don't think that will affect Starbucks that much, so it isn't a real worry. Peet's Coffee and Tea is the main one that comes to mind, and I am invested in them. The thing about Peet's is that they only have approximately 120 stores, and a good portion of their revenue is from grocery store sales. Because Starbucks is already so well established, I think the only question is: Will people in international markets pay $4 for a cup of coffee? I think that a good portion will, a good enough portion to propel Starbucks over the next 10-20 years.

What to look for
I see the following points important to watch:

-- Expansion; As Starbucks expands into China, Brazil, Russia, and India over the next couple years, I see it very important to make sure that they are having good sales in those countries, because that is where their growth will mainly be coming from.

-- Competition; While I don't see any major competition threat to Starbucks, I think it is important that the competition doesn't become too serious that it takes a good portion of Starbucks business away. If a large competitive threat comes, I would see that as the largest risk.

Valuation
When evaluating a growth company such as Starbucks, I like to estimate a future value of the company using today's numbers and estimates. For this, I use the Future Value evaluation technique.

I think 20% growth is a reasonable number to expect out of Starbucks for the next five years (Analysts expect 22%). The current EPS is $0.69. I think a low P/E to expect in five years is somewhere in between 30 and 35, so I'll use 33 for now.

• .69 * (1.2^5) * 33 = 56.66

That's with a low P/E, in my opinion, so let's use the same numbers except with a P/E of 40:

• .69 * (1.2^5) * 40 = 68.68

So, I think a target price of 60 is a good one. Of course if anything major happens I'll re-assess the situation and see what a reasonable expectation is.

Conclusion
To conclude, I feel that Starbucks has been beaten down from almost nothing, and I see this as a great value opportunity for the long-term. Starbucks is a great company with a great base of stores, and I see tremendous potential internationally. I posted a while back that a price below $35 would get my interest, so since it's gotten down this far after an earnings overreaction, I feel it deserves a spot in the Pencils Fund.

David Kretzmann is ninth-grader in Nevada City, CA, and has been writing about and researching stocks and business for nearly a year. He is currently working on a book about stocks. Of the companies mentioned in this post he is invested in Starbucks and Peet's Coffee and Tea.