Starbucks Corporation (NASDAQ:SBUX) can continue growing its dividend at a rapid pace going forward, but a dividend growth rate closer to 13-17% seems more likely. The company is still in investment mode, and management likely wants to keep the payout ratio not much higher than 40%, which is about where it sits today.
Therefore, future dividend growth will be driven by underlying earnings growth, which is expected to average about 15% annually over the next few years.
Given the company’s opportunities for expansion in international markets, continued share repurchases, expanding free cash flow margins (due to scale and technology advancements), and management’s long-term guidance below, the growth forecast doesn’t seem unreasonable.
Source: Starbucks Investor Presentation
Valuation
Despite falling 12% over the past year, from just looking at the forward P/E ratio (28x) or dividend yield (1.5%), you might not think that Starbucks looks undervalued.
After all, the current share price still represents a substantially higher valuation metric than the market’s P/E, and even accounting for the company’s excellent long-term growth investors can be forgiven for thinking that Starbucks is trading at lofty levels.
However, there are two things to consider. First, Starbucks has historically traded at a high premium due to the strength of its brand, the quality of its management, and its long growth runway. In fact, the stock’s average P/E over the past 20 years has been over 40, implying that today’s valuation might not be as high as it seems.
As we’ve seen, Starbucks’ growth runway is still very long and, equally importantly for us, it has the potential for some truly sensational dividend growth in the coming years.
Growing dividends over time is very powerful. For example, Starbuck’s split adjusted cost basis 20 years ago was $2.06. This means that the current dividend represents a 31.6% yield on invested capital. Even adjusting for inflation that still comes to 20.5% and will only grow exponentially over time as Starbucks continues to reward patient, long-term investors.
In other words, while Starbucks may not seem like a screaming buy at today’s price, based on its historical valuations, and more importantly, its realistic forward earnings growth potential, the stock seems like a solid long-term core holding for any diversified dividend growth portfolio.
Even as large as Starbucks is today, it still has the potential to become one of the best performing dividend growth stocks of the next decade if it can achieve its long-term guidance. Essentially, owning Starbucks is a bet that the company’s store concept is not yet saturated but rather has a long runway for growth. If correct, the stock should deliver double-digit annual returns over time.
Conclusion
Despite the concerns over slowing global economic growth, Starbucks continues to fire on all cylinders. Its top notch management has a clear vision for how to continue impressive growth going forward, and that should mean great things for dividend growth investors if the plan is successful.
The stock doesn’t necessarily have a large margin for error at the current price, but its price is very reasonable if the company continues executing on management’s long-term growth plans. Overall, Starbucks looks like an appealing candidate for long-term dividend growth portfolios. That’s not to say the stock won’t suffer a correction with the rest of the market, but such dips merely represent more attractive buying opportunities for this supreme dividend growth stock.
Disclosure: None
