Valuation of the Starbucks Corporation Sample Assignment

Valuation of the Starbucks Corporation

Introduction

The Starbucks Corporation was founded in 1971 and soon became the world’s leading “roaster, marketer, and retailer of specialty coffee” (Starbucks Corporation Form 10K, 2016). After the corporation being officially formed in 1985, the Starbucks Corporation began selling shares on the NASDAQ under the symbol of SBUX. Now, 33 years after the corporation formation, the Starbucks Corporation has thousands of franchised and company owned stores in over 75 countries all over the world (2016). With the Starbucks Corporation holding such a high popularity, it has become of some interest to investors. However, before any investors make the commitment to invest in any corporation, they must protect their assets by looking at the valuation of the proposed company and how it compares to similar companies in their market.

In this report, an analysis on the valuation of the Starbucks Corporation will be conducted. Within this analysis, an in depth review will be done by looking at the income method of valuation by use of the Damodaran Excess Returns Model. With the income method of valuation, this report will also conduct a relative valuation by comparables by conducting both a price ratio calculation and a return ratio calculation. Further explanation of both valuation methods and the inputs gathered from the Starbucks Corporation Form 10K, can be reviewed in the analysis section with all calculations and tables being included in the appendix of this report.

Analysis

Income Method of Valuation

According to Skoda Minotti, CPAs, Business and Financial Advisors located in Cleveland, OH, Akron, OH, and Tampa, FL, there are two income approaches to valuating a company. The valuation of the company by using the income approaches is done by analyzing the amount of income the company is expected to generate in the future by using the Capitalization of Cash Flow Method or the Discounted Cash Flow Method (Saari, 2017). The Capitalization of Cash Flow Model is utilized when there are expected to be stable levels of growth while the Discounted Cash Flow method looks at the company financially as if there were to be differentiation in future margins and growth (2017).

In order to look at the Income Method of Valuation for the Starbucks Corporation, the Excess Returns Model will be used. The Excess Returns Model, as provided in the className, is the replica of the Damodaran Excess Return Model. All data needed for input of the model will be gathered by using the 2017 Starbucks Form 10K provided by the company website. All data which is to be inputted into the model is included in the Appendix under Table 1. After all information was inputted into the data, the Excess Returns Model then calculated the valuation by using Five Years of calculation and cash flows (shown in Table 2 of the Appendix).

With all the information and calculations performed in the Excess Returns Model, the final calculation calculated the Starbucks Corporation value per share to be $16.73. At close on March 1, 2018, the Starbucks Corporation share value was $56.13 which is significantly more than the calculated value per share from the 5 year cash flow as calculated by the Excess Returns Model. The lower valuation provided by the Excess Return Model means that there is a possibility that the Starbucks Corporation stock may be seriously overvalued. However, with a valuation so low, as shown in the calculations for the Starbucks Corporation, it can be hard for investors and analysts to accurately value the stock and determine the appropriate investment strategy.

Relative Valuation by Comparables

Relative valuation, as defined by Damodaran, is the process of comparing the value of a company, as assessed by the market, to other comparable assets. In the case of a share, the principal share of interest needs to be compared to shares of similar businesses. In the case of the Starbucks Corporation, according to the Starbucks Corporation SWOT Analysis published in 2017, as majority of the leading competitors are small businesses which are not incorporated. However, some of the major competitors whose shares are sold on the NASDAQ include Dunkin Brands and McDonalds (Starbucks Corporation SWOT, 2017). For the calculations included in this report in order to analyze the relative valuation by comparables for the Starbucks Corporation, competitive inputs will be gathered for the Dunkin Brands.

After a competitor is selected, the appropriate calculations must then be selected. For this valuation, calculations for both a price-earnings ratio and return ratio will be calculated (calculation shown in the Appendix) and explained.

Price-Earnings Ratio

The Price-Earnings Ratio is the calculation which takes the market price per share divided by the earnings per share (Damodaran). When calculating the price-earnings ratio for a corporation, investors will be able to determine what they must invest in order to earn $1 of the company’s earnings. After the calculation is completed, if the price-earnings ratio is high, then the investors will expect a higher earnings growth compared to the companies that have a lower price-earnings ratio.

In order to calculate the price-earnings ratio, all inputs were gathered from Yahoo! Finance in order to get the most up to date information as of March 1, 2018.

When analyzing the price-earnings ratio calculation, shown in the appendix under Calculation 3, it is evident that the Starbucks Corporation has a decent sized P/E Ratio. However, the ability to accurately analyze the P/E Ratio of the Starbucks Corporation would not be able to be done without comparing it to the P/E Ratio of the chosen competitor, Dunkin Brands. The P/E Ratio calculation of the Dunkin Brands can be shown under Calculation 4 of the Appendix.

When comparing the P/E Ratios of the Starbucks Corporation and the Dunkin Brands, it is evident that the Starbucks Corporation has a higher P/E Ratio than the Dunkin Brands. As mentioned above, when comparing P/E Ratios of the principal company to competing companies, the company with the higher P/E Ratio, as in the case with the Starbucks Corporation, mean that investors can expect to receive a higher earnings growth for all investments in the future compared to if they were to invest in Dunkin Brands.

Return on Investment Ratio

Another way in order to compare the valuation of the principal company with its competitors is by calculating the Return on Investment of the companies. According to Entrepreneur, the Return on Investment is the measurement of profitability which “evaluates the performance of a business by dividing the net profit by the net worth” (Return on Investment, n.d.). With the Return on Investment calculation, investors are able to determine the profitability of their investments by using the money invested by the investor and the realized return on that money. After the calculations are done with the appropriate inputted data, the investors will be able to determine which company is more attractive when it comes to their funds. When comparing the ROI for two or more companies, the company with the higher ROI will be the most attractive investment as that company will have the highest return for the invested funds.

As with the Price to Earnings Ratio, the data to be used in the calculations was again gathered from Yahoo! Finance in order to get the most up to date information as of March 1, 2018. When calculating the ROI of both the Starbucks Corporation and the Dunkin Brands, calculations will be conducted with the idea that an investor is looking to the purchase of only one share on March 1, 2018.

When looking at the two calculations done for both the Starbucks Corporation (Calculation 3) and the Dunkin Brands (Calculation 4) as shown in the Appendix, the investors will be able to determine the percent return they expect with the invested funds. With the calculations, it is evident that the Dunkin Brands investment has a higher percentage for the return on equity with 7% than that of the Starbucks Corporation which is 5%

Comparing the Price to Earnings Ratio and the Return on Equity

After calculations were completed, the two different calculations showed two different results. The Price to Earnings Ratio calculations conducted in Calculation1 and Calculation 2 shows the Starbucks Corporation the favorable investment as it had a higher Price to Earnings Ratio than the Dunkin Brands. However, when it came to the Return on Equity, the calculations conducted in Calculation 3 and Calculation 4 shows the Dunkin Brands being the favorable investment with the Return on Investment ratio and percentage being higher than the Return on Investment ratio and percentage being calculation for the Starbucks Corporation. The most likely cause of this would be due to possible undervaluation of the Dunkin Brand during the Price to Earnings Ratio. With reasons such as this, it is imperative that investors and their analysis conduct even deeper analysis on the companies they wish to invest in along with their competitors.

Conclusion

The Starbucks Corporation is a popular company with thousands of franchised and company owned stores all over the world. With such high popularity, the Starbucks Corporation has the potential to attract investors everywhere. However, in order to appropriately determine whether or not the investors funds will be profitable when placed in the stocks of the company, it is beneficial for the investor and/or their analysts to conduct valuation of the company both on its own and against the company’s competitors to determine its position in the market.

After looking at the Starbucks Corporation valuation, it imperative that investors and their analysts conduct further analyses. However, through the basis of what has been conducted in this report, through the Income Method of Valuation by the Damodaran Excess Returns Model, and the P/E Ratio and Return on Investment calculated for the Relative Valuation, it can be easily determined that the Starbucks Corporation is not a company which should be taken seriously when it comes to long term, large profit investment strategies.

Appendix

Table 1 – Data Inputted for Excess Returns Model

(Starbucks Corporation Form 10K, 2017)

Table 2 – Excess Returns Model - Calculation with Cash Flows

Table 3 – Excess Returns Model – Valuation Calculations

Calculation 1 – Price to Earnings Ratio – Starbucks Corporation{" "}

(Starbucks Corporation Statistics, 2018)

Calculation 2 – Price to Earnings Ratio – Dunkin Brands

(Dunkin’ Brands, 2018)

Calculation 3 – Return on Equity – Starbucks Corporation

= 5%

(Starbucks Corporation Statistics, 2018)