Starbucks Should Not Exist
“Valuing personal connections at a time when so many people sit alone in front of screens; aspiring to build human relationships in an age when so many issues polarize so many; and acting ethically, even if it costs more, when corners are routinely cut – these are honorable pursuits, at the core of what we set out to be.”
- Howard Schultz, founder and CEO of Starbucks
(Onward by Howard Schulz, 2011)
This makes no sense whatsoever …
This is a photo I snapped at the Memphis airport two years ago. As with any Starbucks anywhere, there is a place nearby selling coffee much cheaper – and with no line.
I recall a mini-research project I conducted on Starbucks in 1999 when I was a business school student. Starbucks was no secret back then. They were everywhere in New York – all with lines. My objective was to determine whether there was anything truly special about the coffee. In other words, was this a Coke in the making? Was there anything particular about its taste that made customers willing to spend 3-times as much money and time to procure a coveted cup? Finding no research on this subject online, I resorted to standing outside a Starbucks on Broadway and 110th in 1999, and I polled customers entering the store. What my anecdotal conversations revealed was that most folks were relatively neutral on the coffee itself. Less than half said it was the taste that drew them in; most could not articulate a cohesive reason for why they were enduring Starbucks’ high prices and long lines. If its coffee was not the equivalent of Coke’s secret formula, Starbucks allure, I reasoned, must be derived from its leather chairs and “sexy” merchandising of coffee. These were not competitive advantages that would sustain the assault of skilled competitors over time. In other words, there was no moat around this business. With a rich price/earnings (P/E) ratio in late 1999 of ~40x (more than double the S&P 500’s long-term historic average), I reasoned that Starbucks was grossly over-valued at the time.
So much for being smart. The stock has grown 17-fold in the ensuing 16 years. Many copy cats did their best to steal some of the company’s growth opportunity. I recall seeing several such contenders boldly open up right across the street from a Starbucks throughout New York in the 2000’s. Surely these competitors would eat Starbucks’ lunch – or at least some of it. Nevertheless, Starbucks, for reasons I could not comprehend, still drew the lines.
Looking back, I now understand Starbuck’s magic. It was founder Howard Schultz, who remains the company’s CEO to this day. He’s a reminder that people matter. A lot. Great CEO’s can create enormous value – even in seemingly mundane businesses with no obvious competitive advantages.
Starbucks is also a great example of how a company’s price/earnings ratio may be a lousy proxy for a company’s intrinsic value. In Berkshire Hathaway’s 2000 annual report, Warren Buffett warned that, “Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business.” For more information on why a low P/E stock might be overvalued and a high P/E stock undervalued, please see my video lecture on the subject to Columbia Business School students in 2013.
Lastly, Starbucks is a painful reminder that I have dedicated far too much of my time and energy the past seven years to researching the economy, inflation, and China real estate. No doubt I would be far better off today had I focused those hours instead on hunting for special businesses run by special people. Lesson learned. The good news is that such a focus is not only better for one’s long-term wealth, it is also a more interesting and inspiring way to lead one’s life.
This is where I could use your help. Please let me know whenever you have an “aha” moment – when you spot a special company or a special leader. It might be a company’s product that you buy, or perhaps even a competitor you hate, yet admire at the same time. My ultimate ambition is to enlist the help of you, my clients and friends, in Fielder’s hunt for the truly special. Keep those eyes and ears open!
(Please note: Fielder has no opinion on Starbucks stock. We share the above solely as a case study to illustrate certain principles. We have not conducted research on Starbucks and thus have no educated view on the prospects for the stock going forward.)
Yours in the Field,
Frank Byrd, CPA
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