Is China The Next Starbucks?

If you look at a long-term picture of Starbucks (SBUX) (at least 5 years), you’ll see it looks like a big pile of coffee.  It goes from the bottom left to the top center of your screen and back down to the bottom right of your screen.

Starbucks (SBUX) was one of the darlings on Wall Street for years.  It was growing so fast.  People were not only addicted to the coffee, but the stock as well.  I had people tell me, “You know they’re going to open up a ton of stores in China over the next several years.  How can it go down?”.  My answer was always, “Who isn’t going to do business in China over the next several years?  That doesn’t mean the stock has to go up.”  Starbucks was growing so fast, everyone would joke around about a Starbucks on every corner.  I know for a fact there are at least 3 on some intersections in major cities.  But, then earnings (profits) began to slow.  Investors on Wall Street sell first and ask questions later.  The stock went from $40 to $30 in about a month, 25%!  The growth company was now transforming before our very eyes into a mature company.  The stock peaked around $40 in the summer of 2006 and is now around $16.

After the bell today, Starbucks announced they are closing 600 stores and laying off a bunch of people.  This is the right move.  This company is going through a transition that tons of companies have gone through over the years.  A company in its infancy stages is growing fast.  When profits grow from $1 per share to $2 per share, that’s 100%.  Investors pay up for that growth.  But, it’s hard to keep that growth rate up there.  Then, it grows too fast and becomes a mature company.  Pretty soon the growth just isn’t there and investors aren’t willing to pay too much for one year’s worth of earnings.  So, a P/E (price to earnings) ratio goes from 40 to 15 (just an example; not Starbucks actual numbers).  Wholefoods is going through this transition as well.  It’s the maturation process.  Nobody expects Coca-Cola sales to go up 35% per year anymore.  You look for other reasons to buy the stock.  Perhaps the stock is cheap or perhaps they are dominating their competition or they are buying back stock making your shares more valuable.  Maybe you want a good stable dividend paying recession proof stock.

Now, Starbucks is becoming a value.  Why?  Because investors always take stocks either too high or too low.  Starbucks may not be completely done going down and this isn’t my endorsement for buying the stock here.  But, I do believe it will be a good long-term buy very soon.  They still dominate what they do but they just grew too fast.  Still the best coffee around.  Just pilot error.  Bad management.

That brings me to China.  Doesn’t Starbucks’ story sound really similar to what could be happening in China?  In 2006 & 2007, the average investor finally decided China was really going to grow fast and jumped on board buying all kinds of stocks.  IPOs all over the place.  FXI, which is the ETF that invests in a basket of Chinese companies, went from $60 to over $200.  Everybody loved their growth.  Their growth was addictive.  An economy growing double digits every year.  300 million people industrializing over a 20 year period.  That’s like building the United States from nothing in 20 years.  Wow.  How can Chinese stocks ever down?  Well guess what?  They’ve grown too fast and now everyone is paying the price.  Commodities are flying high and now we’re hearing everyone around the world threatening to raise interest rates.  Global growth is slowing because of this and may continue for some time.  FXI is now trading at $130.  Not a fun fall from over $200.  But, here’s the good news.  I’ve mentioned before when investors take their eye off the ball and forget or doubt global growth, that’s our opportunity.

Is China a value yet?  Probaby not yet.  But, continue to watch it because just as everyone is writing off Starbucks, they are in the process of writing off China.  China will undoubtedly go through slowdowns.  But, at the end of the day they still have the best cup of coffee around….I mean the fastest growth around.

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