Is Starbucks Stock Suitable for Your IRA or Roth IRA? (SBUX)

Shares of Starbucks Corporation (NASDAQ: SBUX) are most suitable for a traditional individual retirement account (IRA), though the company's strong growth outlook could also make the stock a candidate for Roth IRAs. The primary reason why Starbucks is unsuitable for Roth IRAs is its aggressive valuation, which already assumes substantial growth. This limits the potential for asset appreciation, which is necessary for Roth suitability. Though Starbucks is suitable for traditional IRAs, investors should note the low dividend yield.

Outlook

Starbucks has enjoyed sustained rapid growth in both same-store sales and store count. The company has expanded operations to 23,000 stores in 65 countries. Consumer preferences in the restaurant and eateries industry are evolving favorably for Starbucks. Consumers are increasingly choosing fast casual restaurants instead of traditional fast food chains, with nutrition and quality rising in importance relative to price and speed of service. Starbucks brands itself as a premium option, offering a more authentic coffeehouse experience at a higher price point than competitors such as Dunkin' Donuts. Though consumer confidence and disposable income growth are important for demand stability in luxury and premium products, coffeehouses generally sell low-ticket items that are not as cyclical as durable goods.

The company plans to open 1,800 net new stores in fiscal 2016 and achieve 10% revenue expansion. Same-store sales growth above 8% indicates that the company's current markets are not yet fully saturated. Operating margin is also expected to expand slightly. Consensus analyst estimates call for 17.9% compounding earnings per share (EPS) growth over the next five years.

Financials

Same-store sales grew 8% in the quarter that ended in September 2015, bringing trailing 12-month revenue growth to 17.6%. The company opened 1,677 net new stores in the fiscal year that ended in September 2015. This is the highest revenue growth rate achieved by Starbucks since 2007, driven by growing store count, higher customer volume and better pricing across all geographic segments. Operating income expanded 13.4%, which is an impressive figure despite falling short of revenue's pace. Starbucks' growth is superior to peers such as Panera Bread and Dunkin'.

Starbucks posted gross margin of 59.4% for the year that ended in September 2015, the highest level of the past decade. Despite having higher price points, Starbucks has a narrower gross margin than its closest rival, Dunkin' Brands. With an operating margin of 18.8%, Starbucks also trails Dunkin' substantially in terms of operating profitability. The gulf in margins between these peers is due to important distinctions in business models. Dunkin' operates primarily through franchised locations, whereas Starbucks operates nearly 100% of its U.S. stores internally.

Starbucks carries $2.3 billion of gross debt and $737 million of net debt. With a total liabilities to equity ratio of 1.14, debt represents a material fraction portion of the capital structure of the company. Starbucks has a current ratio of 1.19 and a quick ratio of 0.64. With inventory turns of 6.5 and days sales outstanding of 12.9, these liquidity ratios do not indicate any likelihood that the company will be unable to meet its obligations in the near future.

Valuation

Starbucks has a high forward price-to-earnings (P/E) ratio of 28.4. In comparison, Panera's forward P/E ratio is 26.5 and Dunkin's is 19.2. Starbucks' P/E valuation reflects high growth expected by analysts and market participants, with a consensus five-year EPS growth forecast of 17.9%.

The price/earnings to growth (PEG) ratio adjusts P/E for growth expectations and can be a useful tool for comparing valuations of companies with disparate growth expectations. Starbucks' five-year PEG is 1.59, while Panera's is 2.19 and Dunkin's is 1.44.

Starbucks has a 15.6 price-to-book (P/B) ratio, which is very high compared to its peers, though Dunkin' has negative book value. Starbucks' 1.03% dividend yield is significantly lower than Dunkin's, and Panera does not pay a dividend.

None of these popular valuation metrics suggest that Starbucks shares are cheaply priced in absolute terms or relative to peers and companies in other industries. Retirement investments must be made with very long-term goals in mind, so only extremely rich valuations should be sufficient to disqualify a stock from consideration completely. Nonetheless, an investment is generally only sound if it is priceworthy. Valuation analysis of Starbucks indicates some limitations on the potential return that investors can reasonably expect.

Traditional IRA Suitability

Traditional IRAs are ideal for mature, stable stocks that pay dividends. Retirement savers can reduce taxable income by making qualifying contributions to traditional IRAs. These accounts are made to incentivize investment, allowing an investor to benefit from compounding gains on tax-deferred income over the life of the account. Special tax treatment is granted to dividend income generated by account holdings, which can also be reinvested. When a traditional IRA holder retires, withdrawals are taxed as regular income, so capital gains from appreciating assets do not provide any benefits from the capital gains rate. Therefore, traditional IRAs are better-suited for stable dividend plays rather than growth plays.

Starbucks is the world's largest coffeehouse chain by store count, with over 23,000 locations. Close to 13,000 of these are in the United States. With a market cap of $92 billion and market leadership in sales and store count, Starbucks is a large, stable company that is typically suitable in a traditional IRA. The company also paid dividends of 84 cents over the past year, which is 1.36% of the November 2015 market price of $62. Qualitatively, Starbucks is an ideal stock for traditional IRA holders. However, the 1.36% dividend yield is relatively low, with Dunkin' paying 2.53%. There are blue chips in other industries with much higher dividend yields as well. If investors are especially bullish on the Starbucks story and fundamentals, a low dividend yield is insufficient to make the stock unsuitable for a traditional IRA, but the low dividend yield indicates that other options may be superior for maximizing returns.

Roth IRA Suitability

Roth IRAs are designed to help retirement savers benefit from capital appreciation from growth stocks. Though Roth IRAs offer no special tax treatment for contributions, qualifying withdrawals are not subject to any taxation after retirement. If investors are optimistic about a stock's long-term growth prospects, a Roth IRA is an attractive investment vehicle for maximizing returns. Without special tax treatment for contributions or dividends, mature, stable companies are not the best options for Roth IRAs.

Starbucks' maturity and global saturation likely limit the long-term growth potential of the company, though prospects for the next five to 10 years are justifiably strong. Roth IRA holders generally require a longer-term view than five to 10 years. At some point in the next two to three decades, Starbucks' current business model is likely to struggle to generate sustained high growth as the global coffeehouse market becomes increasingly saturated. Given this limitation, the rich valuation of Starbucks is important for determining long-term capital appreciation potential. At $62, significant long-term growth is already assumed in Starbucks share prices, limiting the upside available.

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