Is Starbucks a Buy Near All-Time Highs?

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With shares of Starbucks (NASDAQ:SBUX) trading around $79, is SBUX an OUTPERFORM, WAIT AND SEE, or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

T = Trends for a Stock’s Movement

Starbucks is a roaster, marketer, and retailer of coffee operating worldwide. The company purchases and roasts the coffees it sells along with handcrafted tea and other beverages, as well as a variety of fresh food items through its stores. Starbucks sells a variety of coffee and tea products and licenses its trademarks through other channels like stores and national food service accounts. In addition to its flagship Starbucks brand, the company’s portfolio features Tazo Tea, Seattle’s Best Coffee, Starbucks VIA Ready Brew, Starbucks Refreshers beverages, and the Verismo System by Starbucks. Starbucks has developed a solid reputation over the past several years, which has generated a lot of buzz for its products.

There is probably little doubt in anyone’s mind that Starbucks 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 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.  Second, the company could face rising input costs that could hurt its bottom line. We saw earlier this year that coffee prices soared due to drought fears out of Brazil and a reemergence of European demand. This sent coffee prices rising as much as 80 percent. While coffee prices have come down and while coffee prices don’t significantly impact the company’s input costs, another spike in coffee prices could have enough of an impact to hit this priced-for-perfection stock. Finally, one of the reasons that investors are willing to pay such a premium for Starbucks shares is that interest rates are so low. It follows that stocks are worth more because its earnings yields (i.e. the inverse of their price to earnings ratios) are high relative to interest rates. But if interest rates rise then earnings yields on stocks will likely rise as well, and Starbucks can be hit hard by this.

T = Technicals on the Stock Chart are Strong

Starbucks stock has been trending higher over the last couple of months. The stock is currently trading near all time highs and looks set to continue this path. Analyzing the price trend and its strength can be done using key simple moving averages. What are the key moving averages? The 50-day (pink), 100-day (blue), and 200-day (yellow) simple moving averages. As seen in the daily price chart below, Starbucks is trading above its rising key averages which signal neutral to bullish price action in the near-term.

SBUX

Source: Thinkorswim

Taking a look at the implied volatility (red) and implied volatility skew levels of Starbucks options may help determine if investors are bullish, neutral, or bearish.

Implied Volatility (IV)

30-Day IV Percentile

90-Day IV Percentile

Starbucks options

20.14%

90%

88%

What does this mean? This means that investors or traders are buying a very significant amount of call and put options contracts, as compared to the last 30 and 90 trading days.

Put IV Skew

Call IV Skew

August Options

Flat

Average

September Options

Flat

Average

As of today, there is an average demand from call buyers or sellers and low demand by put buyers or high demand by put sellers, all neutral to bullish over the next two months. To summarize, investors are buying a very significant amount of call and put option contracts and are leaning neutral to bullish over the next two months.

On the next page, let’s take a look at the earnings and revenue growth rates and the conclusion.

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