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Pastimes : Starbucks SBUX

SBUX 88.88

+0.8%

Jan 9 9:30 AM EST

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To: SONAR who wrote (11)	8/6/1996 11:10:00 AM
From: Sturgeon	of 148

Henry, Surprised you're so eager to hear a negative side to SBUX! Didn't think anybody would care. My first point is that SBUX doesn't make much money. In terms of profitability measured by Return on Assets or Return on Equity the profitability is realy quite poor. Very surprising considering the rapid growth of the chain. A company like McDonald's has grown tremendously over the years by having high profitability (ie. high ROE) and reinvesing their profits. With a ROE of 20% (just a guess) McDonald's could grow at 20% per year by reinvesting profits. That's how the great growth companies operate. High profitability reinvested. Starbuck's is NOT the "McDonald's of coffee". Nothing could be further from the truth. McDonald's would laugh at SBUX profitability. Now for the answer to your question. The only way that SBUX can grow as fast as they do is to use an old financing trick (or scam). Because SBUX has such a high price measured by price/book or price/earnings they can issue shares to the public at very, very low cost. Yes there is a dilution effect. But compared to the money raised dilution is trivial. They then invest the money in growing their business. The returns on this investment are low (see above) but it doesn't matter because the cost of raising the money is close to zero. You might not see anything wrong with this but think about it a little. The stock price is very high because the growth rate of the company is very high. The growth rate of the company is very high ONLY because the stock price is high (allowing the form of financing described above). If this sounds rather circular to you, you're catching on. The bottom line is that SBUX is a form of pyrimid scheme. Early investors buy in at very high prices on the expectation that ever larger numbers of investors will continue to buy in at very high prices indefinitely into the future (newly issued stock). Future investors are paying off past investors. I believe that is the classic definition of a pyrimid scheme. If you bought SBUX now you might make money over the long term, but only if enough new investors (newly issued stock) come after you. Just like any pyrimid scheme early investors can make money. But it will have to go on for a long long time before you're out of the woods. When it does end, like all pyramid shcemes it will crash and burn. Once you've understood all this you can start to ask yourself what's going to cause the ultimate crash. I have a few ideas but this post is already getting long. I might post them if anybody's interested.

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