The Big Five1 use their retained earnings as growth fuel. Starbucks doesn’t follow this blueprint, so we question, “Is Starbucks a good stock to buy?”
One of the most vital requirements for management is their capability to create business growth with the most efficient – and it is retained earnings. Problem is, Starbucks has recorded negative retained earnings since 2019. The same year that the coffee maker opened its largest flagship location in the world: The Chicago Reserve Roastery.
Starbucks Stock. Management Highlight. In This Issue.
We begin with the reason why earning should be retained.
To Answer Is Starbucks Good Stock To Buy, We Have To Check Its Business Reinvestment.
Arthur Schopenhauer ever said, “Wealth is like, seawater; the more we drink, the thirstier we become.” We investors are modern Arthur Schopenhauer, we are obsessed not only with profit but more of it. This is the reason why – again and again – the big five’s market capitalization keeps rising: earning growth. Because they can expand business globally and generate more and more profit. Because they could deliver growth even when the others locked down.
Besides the growing market – the opportunity, the main reason behind that spectacular growth is “reinvesting in their own business” or technically speaking,” retained their earning”
Suppose we have a coffee shop that generates $100 in earnings. To expand our business, we decide to keep that $100 instead of giving dividends to our shareholders2. We invest it to buy more coffee makers, open branches and hire more waitresses. This is the concept of retained earnings. When a firm retains its earning, the investor hopes that earnings could be exploited to generate more profit.
Facebook Case
Facebook is one of the best examples of how a company could boost growth with its own resource. From 2016 to 2020 – through the most infectious pandemics in human history – Facebook record no debt3. This means the Social Media Platform relies solely on its retained earnings to accelerate its earning – as you can see in the figure below. By retaining 55 B in 5 years period, the largest social network generated almost an additional 19 B in earnings.
These retained earnings allow Zuckerberg’s firm to re-invest in the future. For instance, to purchase Oculus studio, a VR company. Zuckerberg believes that Virtual Reality is the future communication platform. Facebook also seems serious in payment service – its Libra project – by buying Service Friend and Chain Space as part of its blockchain technology.
One Leaking Cup of Coffee: Negative Issue Answering The Question is Starbucks good Stock to Buy.
By definition, a positive number of retained earnings in a certain period is a representation of how much earning are retained from the beginning till the reported period. For instance, if my coffee shop was founded in 2010 then in 2020 it reported $1.000 retained earnings, we could say that for ten years, 2010 – 2020, my coffee shop keeps that $1.000 earnings.
Instead of accumulating earnings like my coffee shop, Starbucks depletes its earnings. As the figure below shows us, the declining trend even begins in 2016.
Retained Earnings Calculation
Retain Earning is simply calculated below:
Retained Earning at period T = Retained Earning at the period (T-1) + Earning at period T – Dividend at period T
Thus, Retained Earning at 2020 is Retained Earnings at previous period – 2019, plus earning at 2020 minus dividend at the same year.
Thus, for the Starbucks case, we identify two possibilities:
- Too low earning generated
- Too much dividend paid
From 2016 to 2019, The coffee maker’s earnings grew from 2.8 B to 3.6 B4. Shortly speaking it is growing – this leads us to eliminate the first hypothesis and move forward to a dividend case.
Tracking its Cash Flow Statement, Starbucks paid 0.9 B as a dividend for its shareholder in 2015, 5 years later, the coffee purveyor double the dividend paid with 1.7 B. In 2020 – when the lockdown policy hit the bar and restaurant business, Starbucks’ earnings shrink 25%, but management decided to pay almost 2 B dividends. Wait, investors should be happy, right? Even at a difficult time, the firm still paying dividends. Yeah, the investor may happy…
At the moment…
Is Starbucks a good stock to buy? See the problem
If Starbucks could accelerate its dividend program forever, of course, I will jump buying Starbucks stock without a doubt. Unfortunately, this policy isn’t sustainable. An accelerated dividend payment should follow the growing earning, otherwise, we should ask how the firm will grow.
A bull side may argue.
On November 15, 2019, Starbucks opened the largest coffee shop in the world – five-floor, 35,000 square feet – in Chicago, following another premium location that already settled around the globe. The expansion keeps going in 2020, The Seattle-based company opens the second-largest Starbucks in the world located in Bangkok, one of the cities that could tame the coronavirus.
We aren’t going to debate it. It is ok, it keeps growing and opening new stores even with debt. Still, as long as the firm could pay an interest rate, it is ok. But we prefer to invest in a company that uses the cheapest resource for its growth fuel. Like Facebook, or Berkshire Hathaway. Warren Buffett and Charlie Munger never pay a dividend to their shareholder, they roll the money and make the Berkshire conglomeration even greater.
And the cheapest fuel is retained earnings. You could post your moment with friends, hang out with Starbucks Cafè Latte in Facebook – perfect blend, but the two is far different in the term of management skill.
Is Starbucks a good stock to buy? Investor Takeaway
- Starbucks, a company that bans plastic straws, a company that funds clean water projects via its ethos brand. All noble missions but draining their retained earnings and rely its growth on debt. Here we learn that there is no connection between noble creed and real action. No matter how good the story behind the brand, numbers never lie.
- This article is another example of how to assess management. As we ever stated, picking the business with great business advantages is a good first step, picking the one with great management is another level.
- Apple, Microsoft, Facebook, Amazon, Google [↩]
- Why not take a loan from the bank? It is a different question that is not covered in this article but shortly speaking – sometimes interest rate hurts, erode the profit [↩]
- actually, it is ok to take bank loans at the low-interest rate circumstances [↩]
- excluding 2020 due to pandemic effect that could distort our analysis on management treatment regarding retained earning [↩]