Starbucks Steeped in Froth

On Wall Street, great success breeds great expectations, and the stock market's reaction to the second-quarter earnings figures released late Wednesday by Starbucks (SBUX Quote) serves as a perfect example of the traps that can ensnare investors as a result.

The Seattle-based coffee empire sits atop Wall Street's totem pole of admired companies after bringing its so-called coffee culture to the masses. The company consistently outperforms across the board, defying skeptics, and its recent foray into entertainment channels shows that Starbucks is one of those rare companies that can redefine the boundaries of its brand.

The java giant's second-quarter results were no exception to the growth story. It posted a 27% gain in net income, beating expectations, and raised its earnings targets for 2006. Despite all that, the stock sold off after hours -- probably because the 6% comp-sales growth it posted for April merely matched estimates and didn't top them.

Chances are, most traders will forget all about the 6% figure in a matter of days, but the selling was still a harbinger of what might lie ahead when the inevitable slowdown in Starbucks' exceptional growth arrives.

Even after the 1.3% selloff in Starbucks shares after Wednesday's closing bell, the stock trades at roughly 45 times Wall Street's consensus estimates through 2007.

"I think a lot of the growth is priced into this stock already, and people's expectations are very high for it at this point," says Carl Sibilski, managing director with Oyster Capital Management. "I think there's a lot of potential growth for the company to achieve, but the main question is whether you're paying up for that growth before the company achieves it. If you are, the returns will be fairly low in the end."

Starbucks shares have multiplied roughly 20-fold in value since it went public in 1992, blowing away the market's average return. Sibilski himself was positive on the stock for much of that time, but he warns that the party has gotten too crowded (neither he, nor his hedge fund, has a position in the shares). He advises investors to look for growth stocks that are less popular.

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