Be Careful: Starbucks Is Priced for Perfection

Source: http://www.flickr.com/photos/peyri/

Source: http://www.flickr.com/photos/peyri/

There is probably little doubt in anyone’s mind that Starbucks (NASDAQ:SBUX) is a great company. It has developed its own market niche in the United States and in markets throughout the world, and as a result it has turned a $2 drink into a multi-billion dollar business. Even as one of the largest food service companies in the world by sales, profits, and market capitalization, it manages to continue to grow its surprisingly high margin business year after year.

Given this, it is no wonder that the stock is trading near an all time high and at a premium valuation with respect to the broader stock market. But herein lies the problem: the company is performing so well that the stock is priced for perfection, and any slip-up can lead to a significant decline in Starbuck’s share price.

While we haven’t seen these problems yet, they are always lurking, and this is why I think that the best strategy is for investors to wait for a pullback. Granted, this could be a consequence of bad news, but for a company as strong as Starbucks buying shares when people are somewhat fearful makes sense.

But what can drive the stock lower? Such things aren’t readily apparent for a company that is hitting on all cylinders. However, there are risks out there that can drive the shares lower.

First, while a morning cup of coffee is a staple for many people, we should keep in mind that Starbucks sells a luxury. A cup of coffee at Starbucks is far more expensive than it is at, say, 7 Eleven. If the economy weakens — and we saw signs of this in the first-quarter GDP figures — consumers may decide that they want to cut back, and one way of doing so is to cut back on one’s coffee expenses. This could mean making coffee at home or buying coffee at a less expensive establishment. Now, given that Starbucks coffee is an inexpensive luxury, I wouldn’t expect this to take too big a toll on the company’s sales, but as I mentioned above the shares are priced for perfection, and as a result even a small slow-down in sales growth could set the shares back 10 percent – 20 percent.