Is trouble brewing for Starbucks?

It won't take much for this highflying stock's price to cool off.

By InvestorPlace Apr 16, 2012 12:50PM

By Ethan Roberts


Imagine for a moment that you're an extremely astute market timer and you bought Starbucks (SBUX) sometime during early March 2009 for around $8.50. And let's say you've held the stock since then, enjoying a relatively carefree ride to current levels about $60.


That's a not-too-shoddy return of around 600% in a little more than three years!


Now, given that stupendous return, is it time to throw cold water on your coffee beans? If Monday's 3% drop is any indication, it's entirely possible. Let's take a look at Starbucks and figure out whether you should take some profits and look for other stocks that are a little less roasted.


Starbucks seems to be a major beneficiary of post-malaise consumers who are sick of feeling poor or are a bit less worried about their jobs or businesses collapsing. As a result, they're spending discretionary income again.


I often use Peter Lynch's "count the cars in the parking lot" strategy to watch the Starbucks at my local mall, in an effort to discern whether the public is in a generous or stingy mood. In 2006, when the economy was rocking, the lines at this Starbucks were a mile long. But in 2009, you could walk right up to the counter and order that overpriced Cinnamon Dolce Frappuccino.


Once again, the lines at Starbucks are deep, although not nearly as intensely as in 2006. But will that trend continue, and has the new demand been factored into the current stock price?

The bullish case

Investors continue to bet the answer is yes. On Friday, as all three major indexes sank, Starbucks, by contrast, rose a whopping 1.72%. As I recently noted, a stock that shows strong relative strength on a bad market day is a stock that's usually worth owning for a while.


Despite the doubling in price since last September, Starbucks continues to pay a decent annual dividend of 68 cents per share. The announcement of the Verismo line of single-serve coffee makers has hammered Green Mountain Coffee Roasters (GMCR). And, of course, the lines are still strong at my local mall. If the economy continues to improve, companies such as Starbucks will derive the benefit.

The bearish case

Starbucks will report its next earnings on April 26. Expectations are for earnings of 39 cents per share, with $3.18 billion in revenue. And it's entirely possible that SBUX will meet those expectations. But will that be enough to propel this stock forward after such an extensive run-up? Recall how often we see overextended stocks get slaughtered simply because they don't greatly exceed the analysts' expectations.


There are four reasons to make a bearish argument on SBUX right now:


First, I have some concerns about recent insider selling. Five company insiders -- CEO Howard Schultz, officer Paula Boggs, officer Clifford Burrows, director Mellody L. Hobson, and officer Troy Alstead -- have been recent heavy sellers on the open market in the $51 to $53 range. Schultz alone has sold more than $74 million worth of stock since March 13. The stock price is now about 15% higher than where these execs sold. If multiple insiders are nervous at these levels, shouldn't investors be as well?


Second, the technical indicators are overbought -- with a relative strength index (RSI) of around 70 (accounting for Monday's sell-off) and a stochastic of around 90. While overbought does not mean done, it does mean that investors who are long need to tighten their stops and those who are contemplating a purchase should consider waiting for a better opportunity.


Third, Starbucks has decided to expand its core business by taking on Green Mountain with single-serving coffee makers and Jamba Juice (JMBA) with a new juice line. When a company begins to deviate from its main product line, it's taking on a greater risk. What happens if consumers don't like the coffee makers or the juice?


Fourth, right now, the price-earnings multiple of SBUX is about 36. While some companies can survive a high P/E for a while, it's not the best time to be chasing a stock.


Then there are the unknowns, such as high gasoline prices and a possible recession in Europe. While markets can climb a wall of worry, I don't want to own a company that sells a nonessential product while consumers figure out how to fill up their cars without busting their budgets.


So for me, Starbucks is a stock to admire -- but definitely not one to own at current levels. It wouldn't surprise me to see it go a little higher, and there are options plays to set up for a possible fall. However, for the moment, rather than assume SBUX can keep climbing, I'd rather sit back with a nice cup of coffee and peer through my charts for a better opportunity.


As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.


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