Grande Expectations: A Year in the Life of Starbucks' Stock

by Karen Blumenthal

Overview

Karen Blumenthal, like most people, is mystified by the stock market. Just why is it, she wonders, that seemingly good news can send a stock plummeting and bad news can send it skyrocketing again?

In Grande Expectations, she shows how money is made and lost by following one of America’s hottest growth stocks, Starbucks, through a year of rapid store openings, fancy new drinks, and clever promotions, revealing how the many players—big and small investors, company management, analysts, and the media—propel its shares up and down.

Blumenthal pulls back the curtain on the stock market to expose its quirks and inner workings, from the power of a penny of earnings and the unexpected impact of a stock split to the image-enhancing effects of a brand of bottled water. With a fly-on-the-wall, character-driven narrative, Grande Expectations not only makes investing interesting but also will help you make smarter and savvier investing choices by:

•Understanding how big pension and mutual fund managers decide whether to buy more Starbucks—or dump it

•Seeing the unique ways that analysts and other finance professionals assess an investment—dissecting not only the numbers but also the company’s management, demographics, and global opportunities

•Learning how Starbucks executives manage our expectations and keep excitement percolating about the business—and the stock

•Watching how a stock is traded and how that might affect your buying or selling

•Gleaning how multibillion-dollar private hedge funds make money on infinitesimal changes in a stock’s price

•Entering the dark, strange world of the short sellers

•Realizing how different people can make absolutely opposite bets and all still come out ahead

You’ll come away with new insights into how the stock market really works—the power of expectations, stock buybacks, and profits—and explore Starbucks’ phenomenal growth and whether it is sustainable. By unraveling the market’s mysteries, Grande Expectations shows how investing can be both profitable and understandable. Get ready for the ride of your life—and a lifetime of fruitful stock market success.

Product Details

ISBN-13:	9780307394118
Publisher:	Crown Publishing Group
Publication date:	04/03/2007
Sold by:	Random House
Format:	eBook
Pages:	320
File size:	411 KB

About the Author

KAREN BLUMENTHAL has been a business reporter or editor for nearly twenty-five years, including two decades at The Wall Street Journal. Her previous book, Let Me Play: The Story of Title IX, won the Jane Addams Children’s Book Award for older children. Six Days in October, a book for young people on the 1929 stock market crash, was named a Robert F. Sibert Honor Book by the American Library Association.

Read an Excerpt

Chapter 1
January
NEW YEAR


There’s a difference between a good company and a good stock

On the first trading day of 2005, the stock of Starbucks Corporation took a breather. The price dropped more than $1, to $61.14, on about twice the usual volume of trading. For investors it was a chance to cash out some gains, especially since the turn of the calendar would keep the profits away from the tax man for another year.

The pause seemed like a well-deserved break following a glorious year for the company that taught America to love lattes. In 2004 more than 1,300 new stores were opened, keeping Starbucks near the top of the list of the nation’s fastest growing retailers. The chain expanded in France, Spain, and even China, and its international business turned solidly profitable for the first time.

In the spring American consumers quaffed up a rich concoction first invented in London stores to celebrate Wimbledon, the Strawberries and Crème Frappuccino. A few months later the company’s first-ever special drink for autumn, the Pumpkin Spice Latte, debuted to even more acclaim. In October an across-the-board 3 percent price increase on beverages, the company’s first hike in four years, added to the top line. Then during November customers flocked back to enjoy the holiday lineup of Peppermint Mocha, Eggnog, and Gingerbread Lattes. Starbucks even seemed to have an unerring musical ear: The album of Ray Charles duets that it coproduced, Genius Loves Company, coincided with the Oscar-winning biographic movie and, unexpectedly, the singer’s death. With the CD on prominent display on Starbucks counters, the chain sold hundreds of thousands of copies, helping the album go multiplatinum and become the singer’s best-selling record of all time. Genius Loves Company would later win eight Grammy awards.

With everything clicking, Starbucks hit one financial home run after another. Sales went through the roof at stores open at least thirteen months, a key measure of retail success. While the company predicted that so-called same-store sales would grow 3 percent to 7 percent each month, give or take, the actual same-store sales growth began to jump in double digits: 12 percent in January, 13 percent in February, 12 percent in March, 11 percent in April, only retreating back to single digits in the slower months of August and September. By the end of the company’s fiscal year on October 3, 2004, Starbucks’ revenue had soared 30 percent, and earnings had rocketed up by 46 percent over the previous year. The year’s profit, $389 million, or 95 cents a share, beat Starbucks’ own early projections by 10 cents a share. It was, by all accounts, a remarkable performance.

The stock had climbed steadily all year, but in the last three months of 2004 it skyrocketed, propelled in part by a tepid stock market that suddenly turned hot after the November elections. Starbucks officials, recognizing the stock price might be overheating, tried to cool some of the fervor. In a press release announcing that overall November sales had jumped 26 percent and same-store sales had grown 13 percent, Howard Schultz, the company’s chairman and chief global strategist, warned, “It is important to note, as we have said in the past, that comparable store sales growth of the extraordinary level achieved in November is not sustainable.” Instead, he said, same-store sales of 3 percent to 7 percent were “the right level for longer-term expectations.” The stock price climbed some more.

During the trading day on December 30, 2004, Starbucks briefly hit an all-time high above $64 a share, almost double where it started the year. After slipping a bit on December 31, it would end 2004 at $62.36, up a jaw-dropping 88 percent. By contrast the Standard & Poor’s 500 Index rose a healthy, but far less robust, 9 percent. Both The New York Times and the Financial Times singled Starbucks out as a new economy stock market winner, putting it in the same crowd as technology gems Apple Computer, Google, Yahoo!, and eBay.

Those who hadn’t owned the stock wished they had. John F. Jostrand, manager of William Blair & Company’s Growth Fund, told his investors in his firm’s annual report that the fund’s stock picks had performed fairly well in the year. But the portfolio had lagged the S&P 500. One significant reason? The fund had declined to own Starbucks and eBay, giving it a “weak relative performance” compared with the broader index.

In other words, their success made the Blair fund look bad.

Though Sharon Zackfia, the research analyst at the Chicago brokerage firm, had recommended Starbucks as a “buy” all year, the fund managers didn’t own it or eBay “due to their significantly high valuations.”

Starbucks was in fact very pricey—and had been for virtually its entire public life. In the parlance of Wall Street, it was a hot growth stock. Unlike “value” stocks, which were attractive because they represented some kind of discount or bargain to their true value, growth stocks might carry a price way over and above any rational assessment. Value stocks were grounded in analysis, but growth stocks ultimately were a leap of faith, a belief that sales and profits would continue to grow and grow, and that investors would jump at the chance to pay princely sums for that expansion.

At the 2004 closing price, buyers of Starbucks stock clearly had grand expectations for their investment. They were paying more than $60 a share for a company that had recently earned less than $1 per share, a price-to-earnings ratio of roughly 65. By contrast, the typical stock was selling for about 20 times earnings per share. The price-to-earnings ratio was something like an SAT score for stocks, a number that let investors compare stock prices within industries and between them. That measure of relative price, as I would learn on this journey, could be a large part of the stock-purchase equation—or largely overlooked. Professional investors bought and sold for all kinds of reasons, and both the actual price and the price as it compared with others were just two of them. When new clients hire Voyageur Asset Management to manage their pension or retirement money, the fund managers buy the same portfolio that everyone else has, regardless of the price at the time—just like when you or I buy into a mutual fund. So Voyageur was buying Starbucks for new clients even as the stock hit new highs.

In Akron, Ohio, Robert Stimpson, a portfolio manager for Oak Associates Funds, was busy assembling a brand-new mutual fund. After working for eight years as a financial analyst at Oak and other firms, he now had his own pool of money on which to build a reputation. For several months he had been sorting through technology names, financial services companies, and energy stocks for just the right mix for his Rock Oak Core Growth Fund, a diversified alternative to the well-established, much bigger White Oak Select Growth Fund, which focused on the volatile businesses of health care, technology, and financial services. Starbucks hit Stimpson’s radar screen early and stayed there.

Tall, slim, and serious, Stimpson knew Starbucks was an expensive stock, but he was willing to pay a premium for consistent growth, partly because he was looking to own the stock for as long as three to five years. He liked Starbucks’ potential to expand around the world and the appeal of its coffee to people young and old. He liked its aggressive store-opening plans, and he particularly liked its steady sales and profit growth, increases that were so year-in and year-out consistent, you could chart them with a ruler. Few companies that size were expanding so fast.

He saw the stock as a key part of his fledgling $10 million fund, but, he admitted, this high-priced diamond could languish in his portfolio, or worse, act as a drag on his whole fund just as he was pulling out of the gate. “I wish I had the opportunity to build the initial position at a lower price, but timing the market is very difficult on January 1,” he said. Starbucks’ price “scares me a little,” he added, “which is why it’s not a top five holding” in his portfolio. On January 3, the year’s first trading day, he bought 900 shares of Starbucks stock at $61.07. Over the next few days, he added 1,200 more shares at prices between $60 and $60.32. It quickly became one of his ten largest holdings.

By contrast Don Hodges, working from a historic mansion converted into a comfortable office near downtown Dallas, looked at Starbucks’ price in the new year and had a different reaction. The seventy-year-old money manager had made a good living investing for several hundred clients, but one of his favorite ventures, a small mutual fund he ran with his son, hadn’t won the kind of investor attention he thought it deserved, despite some impressive returns.

Slowly that was beginning to change. The previous spring Fortune magazine had asked him for a stock pick. He recommended Starbucks, one of the better-known stocks in his eclectic mutual fund portfolio, which included companies of all sizes and industries. Hodges had watched the stock and felt like its strong sales and fast growth would send it upward. When Starbucks did climb, the Hodges Fund got a nice jolt—and a second nice mention from Fortune. By year end the fund was ranked first on several lists of top-performing funds in its category. Now those top-of-the-charts rankings were bringing in new investors.

To keep them Hodges needed more winners like Starbucks. But did he still need Starbucks?

Hodges, whose soft-spoken, slow-talking style was more undertaker than Wall Street whiz, began to wonder. From his vantage point, Starbucks was looking pretty overpriced. If that were true, the racehorse in his portfolio could quickly become the mule, underscoring that old Wall Street adage that there’s a big difference between a good company and a good stock. On January 5 he dumped 10,000 of his fund’s 40,000 shares at $61.02 a share. “I still think Starbucks is probably one of the outstanding companies in America. They seem to have done everything right,” he said not long after his sale. In fact, two or three years from now, with thousands more stores open, the stock “more than likely is going to be higher than it is now,” he said. But that might not be the case this year.

His hunch paid off. That afternoon after regular trading ended, Starbucks said that its revenue for the crucial month of December, the biggest sales month of the calendar year, had climbed 22 percent from the year before. More impressive, same-store sales had jumped 8 percent from the previous year. Customers clearly still craved Starbucks’ coffee, its gift cards, its mugs, and all the goodies that went with them.

It was great news. But it wasn’t what Wall Street expected to hear. Investors had come to expect more caffeine-laced results to justify that overheated stock price. The analysts who tracked the stock had predicted same-store sales would be 9 to 11 percent higher than a year ago. The actual number wasn’t just a cooldown; it was a letdown.

The next day in heavy trading on the Nasdaq Stock Exchange, the company’s shares slid 3 percent, falling nearly $2, to $59.74. The next day the share price dropped again. The next trading day, January 10, Don Hodges sold another 5,000 shares at $58.75—and Robert Stimpson picked up 1,300 for his new fund at a similar price, $58.67. But sellers outnumbered buyers and the stock lost another 3 percent in value, tumbling like a toy clunking down a staircase. In fact every day for a week the stock fell, until it had dropped 10 percent of its value, or about $2.5 billion of shareholders’ wealth.

Less than two weeks into January, the stock that every portfolio wanted to boast about in late December was a stock that many could do without. Fundamentally nothing had changed. The company continued to open its predicted number of stores, customers stood in line morning after morning, and billboards and in-store posters touted a new product, a rich drinking chocolate called Chantico, an elixir intended to bolster afternoon and evening sales.

On January 26 the company reported record first quarter profits for the quarter ended January 2 and raised its estimates for its fiscal 2005 net income, telling investors it now expected to earn $1.15 to $1.17 a share, up two to three cents a share from its previous projection. That should have been a pick-me-up, but Wall Street again was disappointed. Stock analysts at some of the big brokerage houses already were projecting year-end earnings in the new range. And they heard a cautionary tone in the company’s comments on an earnings conference call with big investors: Between the lines, Starbucks’ executives were saying the breathless double-digit same-store sales growth of 2004 was over. At least for the time being the sales growth in existing stores would be in the range of 3 percent to 7 percent, solid—impressive even—but not the superstar levels of a few months before. The next day the sinking whoosh coming from the stock was the sound of air escaping from investors’ inflated expectations—and the deflating of the price-to-earnings ratio. The shares dropped $2 more, to close at $53.03. They would rebound only slightly in the last couple of trading days in the month.

Beyond the company’s comments there had been just one key clue that the stock might be headed for an adjustment—had investors been watching closely. Academics had long noticed that buying and selling by insiders—that is, executives and directors—can be a signal about where the stock price might be headed. Howard Schultz, the energetic company leader who knew Starbucks better than anyone, exercised some stock options every year, but he tended to sell mostly when the price was up. In October both he and Orin Smith, then the chief executive officer, exercised stock options and sold the shares when the price was in the low $50s. Smith, who had announced his planned retirement in March, reaped a $59 million profit, while Schultz made a little more than $10 million.

But in the last ten days of the year, as the stock price moved from $59 into the $60s, Schultz stepped up his selling. He exercised options and then sold close to 500,000 Starbucks shares, giving him a late December profit of more than $26 million. When the required disclosures were made with the Securities and Exchange Commission in the week between Christmas and New Year’s, hardly anyone noticed.

Months later in an interview, Schultz acknowledged that there had been “an artificial rise” in the stock price at the end of 2004. But had the stock ever been overvalued? “No,” he said emphatically. “The stock is undervalued. I’ve said that since we’ve been public.”

In another interview he shrugged off the timing of his sales. “I don’t remember that,” he said, when asked about the transactions. “How much did I sell?”

When reminded he added that he and his wife meet with advisers who make estate-planning recommendations, often resulting in year-end sales. His last previous sale before October 2004, however, had been in summer 2003. And in previous years he had sold stock in February, March, and June, as well as December.

“I gotta tell you,” he added, “if we caught the high, we were fortunate.”

Table of Contents

Preface viii Introduction 1
1 January - A New Year 9
2 February - The Annual Meeting 19
3 March - The Stock 35
4 April - The Growth 59
5 May - Buybacks 81
6 June - The Investors 93
7 July - The Trader 115
8 August - The Coffee Moat 137
9 September - The Stock Split 159
10 October - Same-Store Sales 167
11 November - The Analyst 191
12 December - The Earnings 215
13 January - The Annual Review 233 Epilogue - Another New Year 255 Notes 275 Selected Bibliography 297 Acknowledgments 299 Index 303

Editorial Reviews

Veteran journalist Blumenthal, whose most recent stint was with the Wall Street Journal, gives us a twofer with her informative, well-researched and very readable book. She takes a look at the factors that move a blue-chip stock these days--in this case, Starbucks--while weaving in the fascinating history of a company that 20 years ago experts would have said couldn't exist. After all, coffee consumption per capita in the U.S. peaked in the early 1960s, and coffee itself is the ultimate commodity: Everyone can make it, and everyone sells it. Yet Starbucks has been a soaring success, with margins that "profiteering" oil companies and others would absolutely drool over. (13 Aug 2007)
—Steve Forbes

Forbes Magazine

"If you want to know why a stock goes up and down, if you want to be able to make money with that information, this book is for you. I have never ever seen such an indepth and fascinating look at how a growth stock works. This book, while having a great read on Starbucks, transcends that one stock and gives you a tremendous insight into how the whole market works."
—Jim Cramer, Markets commentator for thestreet.com and host of CNBC’s Mad Money with Jim Cramer

From the Publisher