Saturday, March 29, 2008

Illustrating Market Value vs. Intrinsic Value with Starbucks

Starbucks is favorite company of mine to use in various finance and business strategy lectures, (and to get a jolt before our Sunday strategy meetings at Altos Research). Over the past decade, Starbucks enjoyed a steady rise up, initiated aggressive international expansions plans, and with their recent reappointment of Harold Schultz as CEO, is now working to repair some erosion of their brand and product quality.

Most recently, I’ve been watching the Starbucks’ market valuation plummet over the past year with great intrigue. The current share price movement provides another great illustration of the difference between "market value” of a firm and the actual “intrinsic value” of a firm

In early January 2007, SBUX traded at about $35/share, yielding a market capitalization of over $25 billion (=$35/share x 725 million shares outstanding). At Friday’s market close, SBUX traded at $17.05/share, yielding a market valuation of only $12.36 billion.

While the company is focusing itself on re-establishing its brand, quality, service, and products, there certainly haven’t been any fundamental shifts in the demand for coffee. It doesn’t appear that Starbucks customers are flocking to Peet’s Coffee & Tea or Caribou Coffee to get their daily caffeine fix. Share prices at Peet’s are down about 20% since last year, and shares of Caribou have fallen from about $7/share to $2.75 in the same period. McDonald’s is rolling out a plan to compete in the specialized coffee business and their stock is up from $45/share to $55/share over the past year, but can they really take significant market share from Starbucks? Probably not.

So have operations at SBUX really taken such a negative turn that the company is now worth less than half of its value from early 2007? Clearly stock market thinks so, but this is why there is a difference between market value and intrinsic value.

When SBUX traded north of $30/share, that run up was based on increased demand for the market supply of shares (the 725 million outstanding). Strangely, in the middle of this run-up, the stock had a 2:1 split which changed the supply from about 362 million shares to the current 725 million shares outstanding. Supply doubled and the demand continued to force the market price per share to the $40/share range. The change in price reflects increased demand for shares, not necessarily a change in the intrinsic value per share of Starbucks.

According to Starbucks’ financial statements, the company increased its net income over 33% and increased their assets by over 50% in this two-year period. Let’s look at the market price per share during this same period.

In January 2005, SBUX traded at about $30/share. Taking into account the 2 for 1 stock split in October 2005, this means that the shares trading at nearly $40/share in April 2006 were really trading at $80/share. From at the same time that SBUX increased net income by 33% and increased their company assets by 50%, individual shares (actual pieces of ownership of the company) increased in value by over 250%. This means that the market value of a share of SBUX was increasing at a pace much faster than the actual value of the Starbucks.

Remember, market value ≠ intrinsic value.

Read the financial statements. Look at the assets and cash before making a decision on any company’s value – public or private. This isn’t my own idea, Ben Graham and David Dodd wrote about this in Security Analysis and this has long been the mantra of Warren Buffett.


Digg!


2 comments:

KrisztiƔn Fekete said...

Ok.
It was interesting. But tell me what is the intrinsic value of Starbucks now in Maj.2008?
I really would like to hear your oppinion.
My oppinion is that it is way under ints intrinsinc value (around $40-45) currently trading at $16.
It's a good buy now :-)
What do you think?

Scott Sambucci said...

Hi Krisztian -

Thanks for your comment. It's a bit difficult to calculate in the near term because SBUX has had some erractic cash flows over the last few quarters with the corporate changes underway.

I tend to look at their baseline assets from a market value perspective and go from there. I use market value instead of book value because the book value of some of their assets is assuredly less than market value, particularly the value of the real estate that they own across the world.

Just taking the book value of their shareholder equity using the March 2008 quarterly statement, you get $3.34/share. I would guess that number to be higher if we could estimate market value of some of the key long-term assets.

Personally I think that the $16/share is a good price (disclosure: I do own some SBUX stock) and am optimistic about the direction of the company long-term. The brand-name and market share is too good to ignore. But of course, time will tell.