Why I’m Buying Frappuccinos But Won’t Bite into Starbucks

I’ve got something to confess — I generally begin the day with a cup of java from Starbucks Corporation (NASDAQ/SBUX). Heck, sometimes, I don’t even mind paying the $3.00 or so for a “Frappuccino.”

 Starbucks, with over 9,500 retail outlets worldwide, has created a strong brand among coffee drinkers, akin to what McDonald’s Corporation (NYSE/MCD) has done in fast food.

 Nevertheless, the stock has been struggling, currently trading just above its 52-week low of $44.18, achieved on September 27, 2004, and 28% down from its 52-week high of $64.26, reached last December 30. Soft quarterly earnings have been driving the shares down. Starbucks has met earnings estimates in two of the last four quarters and has outperformed in the other two quarters… but only by a mere 3.1%. These are not numbers investors want to see in a stock that trades at 31.56x its estimated FY06 EPS and a PEG that is somewhat top heavy at 1.66.

 Starbucks needs to jumpstart its operating results in order to demand a higher premium. Otherwise, I view the upside as limited. The stock is trading below its key 50-day moving average of $49.72, as well as its 200-day moving average of $51.50.

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 Now, would I buy the stock at the current price? Given the poor operating results and lack of growth, it is hard to justify buying Starbucks these days, despite it trading near its 52-week low. I could be wrong, but I believe there are better stocks in which to put your capital.

 On Wednesday of last week, the company announced it would initiate its fifth stock split since going public in 1992, splitting its shares on a two-for-one basis, effective October 24, 2005. So why split now? A vast majority of companies generally split a stock when the price is trending higher to increase liquidity. Starbucks is not in this situation. I believe the stock split, which will result in a new post-split share price in the low $20.00 range, is designed to give some life to the stock price.

 Based on the initial market reaction, the strategy worked. The company may also be trying to attract smaller investors with a lower priced stock. Whatever the case, I’m not biting. Sure, the stock could trend higher after the split, driven by more liquidity, but the underlying fundamentals have not changed. And in this market, I doubt investors will be fooled. At least, not this one!