I am writing today to help inform people who are new to the stock market and want a simplistic look at the return on Starbucks Corporation (NASDAQ:SBUX) stock.
Starbucks Corporation (NASDAQ:SBUX) outperformed the restaurants industry on the basis of its ROE – producing a higher 93.06% relative to the peer average of 13.89% over the past 12 months. But what is more interesting is whether SBUX can sustain this above-average ratio. A measure of sustainable returns is SBUX’s financial leverage. If SBUX borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. View out our latest analysis for Starbucks
Breaking down Return on Equity
Return on Equity (ROE) weighs Starbucks’s profit against the level of its shareholders’ equity. An ROE of 93.06% implies $0.93 returned on every $1 invested, so the higher the return, the better. If investors diversify their portfolio by industry, they may want to maximise their return in the Restaurants sector by investing in the highest returning stock. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Starbucks’s cost of equity is 9.95%. Given a positive discrepancy of 83.11% between return and cost, this indicates that Starbucks pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Starbucks can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. ROE can be inflated by disproportionately high levels of debt. This is also unsustainable due to the high interest cost that the company will also incur. Thus, we should look at Starbucks’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands at a balanced 138.52%, meaning Starbucks has not taken on excessively disproportionate debt to drive its returns. The company is able to produce profit growth without a substantial debt burden.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Starbucks’s above-industry ROE is encouraging, and is also in excess of its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Starbucks, I’ve compiled three fundamental factors you should further examine:
- Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Valuation: What is Starbucks worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Starbucks is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Starbucks? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!