Investors Should Wake Up and Smell the Value in Starbucks

 | Jul 08, 2018 | 10:00 AM EDT
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There's a bright side to a low price. Traders who like the stock that was hit get the chance to buy in cheaper. Option sellers get the chance to lock in even better prices than outright buyers.

For Starbucks Corp. (SBUX) , the drop from nearly $62 in late January to less than $49 at midyear has left the coffee merchant at its lowest price-to-earnings (P/E) multiple and its highest yield in years.

Starbucks' profit growth has slowed. Same-store sales increases are meager. Did the stock's decline of more than 20% make up for those disappointments, though? Let's find out.

The data below reflect the already-reduced, revised earnings-per-share estimates for 2018 and 2019. Starbucks' average P/E since 2010 has been 26.5x. A typical yield over those eight years ran about 1.40%.

The stock's three "should have sold" moments (red-starred below) showed that Starbucks can command multiples of 31x to 40x when the mood is bright. It doesn't seem far-fetched to think Starbucks ultimately can bounce back to at least a 23x multiple sometime between now and the end of 2019.

That assumption plus modest earnings growth over the coming 18 months would support a Dec. 31, 2019, target price of about $59. Achieving that price would translate into a total return of around 25% for investors buying now and willing to hold until then.

The goal is far from an upper limit. Starbucks topped out at between $61 and $64 during each of four years from 2015 through 2018 year to date on lower EPS and skimpier dividend rates than are in effect today. The recent dividend increase has SBUX paying a generous 2.95% current yield based on its mid-year close of $48.85. That's more than twice the stock's historical yield.

Independent research firm Morningstar is more bullish on Starbucks than I am. It rates SBUX as a four-star (out of five) buy while putting present-day fair value at $64. Morningstar also calls the company's management "exemplary," something it doesn't bestow lightly.

If you believe Morningstar's projections, Starbucks could rally more than 30% within a year, plus reward investors with any dividends paid along the way.

Option writers with 18-month time horizons might be able to capture much of the upside without needing to own the shares. Actual bid/ask prices on SBUX Jan. 17, 2020, expiration date $45, $50 and $55 strike prices are shown below.

Worst case, the forced purchase price dropped to a range of 5.8% to 15.4% below SBUX's already reasonable July 1, 2018, valuation.

Even the most aggressive $55 strike price puts will expire worthless if Starbucks hits just my conservative target price for the end of 2019.

Maximum profit on these or any other option sales is keeping 100% of all premiums received up front. In these examples, that would range from $360 to $890 per 100-share commitment.

Outright buyers of Starbucks at $48.95 would need to see a move to $57.84 to pocket as much as the seller of a $55 put would make if the options ultimately expire unused.

Starbucks is a high-quality company suffering from what might prove to be a temporary growth lull. Perma-bears should avoid the name, but fans of the company might want to own a few shares or short some puts while the price is depressed.

Caffeine is a stimulant that could end up invigorating not just drinkers of Starbucks coffee, but the company's shares, too.

(This commentary originally appeared on Real Money Pro on July 5. Click here to learn about this dynamic market information service for active traders and to receive daily columns like this from Paul Price, Bret Jensen and others.)

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