Starbucks (SBUX) has proven one of the most successful IPOs in history. Since its IPO in 1992, the stock has posted an impressive 200-fold rally, without taking its dividends into account. Nevertheless, as the company has paid a dividend only in the last nine years and has generally offered a low dividend yield, most income-oriented investors have stayed away from the stock. In this article, we will analyze why income-oriented investors should not underestimate Starbucks.

Performance Record

Starbucks has exhibited impressive consistency in its performance. It has grown its annual revenues by more than $1 B for nine consecutive years. During this period, it has grown its earnings per share almost ten-fold, from $0.26 in 2009 to expected $2.40 this year. Thanks to this exceptional performance, the stock has significantly outperformed the market over this period, as it has rallied 498% whereas S&P has advanced 165%. In other words, the stock has tripled the performance of the broad market.

Growth Prospects

While it is impossible for Starbucks to continue to grow at its historical pace, the company has ample room to keep growing at an attractive rate for several years. Starbucks is different from the other well-known multinational food & beverage stocks, such as Coca-Cola (KO) and General Mills (GIS), which have reached a saturation point in the U.S. Starbucks is still growing its revenues at a fast pace in the domestic market thanks to the opening of new stores and same-store sales growth. In the last five years, Starbucks has increased its U.S. store count at a 5% average annual rate. Moreover, Starbucks currently has operations only in 76 countries. This is in sharp contrast to most other popular multinational companies, which have already expanded in almost every country in the world.

Even more importantly, Starbucks has tremendous growth potential in China. The company opens a new store in China every 15 hours (!) and can continue to open new stores at this rate for several years, according to its legendary previous CEO, Howard Schultz. Thanks to this momentum, Starbucks is poised to have approximately 6,000 stores in China by the end of 2022. The growth potential in China is immense, as this market will eventually exceed the size of the U.S. market thanks to the boom of its middle class, whose population will exceed 600 million by 2022.

Dividend

Income-oriented investors have always stayed away from Starbucks due to its lackluster dividend yield. However, it is critical to realize that the company has always offered relatively low dividend yields thanks to its exceptional growth potential. When a company has so exciting growth prospects, it is much more profitable to reinvest the earnings in the business than to distribute them to the shareholders.

Nevertheless, as Starbucks cannot keep growing at its historical pace, it has begun to have a much more attractive profile in its shareholder policy. The stock currently offers a 2.6% dividend yield. While this yield is higher than the yield of S&P (1.7%), it still seems too low to most income-oriented investors. However, it is critical to note that management has been growing the dividend at a markedly fast pace of at least 20% per year. In addition, as the payout ratio is still healthy, at 60%, management can continue to raise the dividend at a double-digit rate for years. This factor renders the dividend of Starbucks particularly attractive.

While Starbucks has raised its dividend by more than 20% per year for nine consecutive years, we will conservatively assume that the company will raise it at a 15% average annual rate over the next five years. As a result, those who purchase the stock at its current price will essentially enjoy a 5.2% yield on cost in five years from now. In other words, as long as the shareholders hold patiently the stock for years, its yield on cost will become increasingly attractive over time and will soon become sufficient to satisfy even the most demanding income-oriented investor. Income-oriented investors should not be myopic and focus only on the current yield of a stock. Instead they should pay attention to the most likely path of the yield on cost. Thanks to its dividend growth record, its healthy payout ratio and its exciting growth prospects, Starbucks is certainly attractive from the perspective of yield on cost.

Final Thoughts

Starbucks has traded within a very narrow range during the last three years. This has mostly been caused by the rich valuation it had three years ago, as the market could not help pricing the exciting future growth prospects in the stock. However, investors should realize that the stock will not remain range-bound forever. Whenever the stock has traded range-bound in the past, it has always broken up to new all-time highs. Given the ample room for future growth, this pattern is likely to repeat once again. Therefore, income-oriented investors should purchase the stock before it breaks up to new highs and lock up its current 2.6% dividend yield. While this yield may seem lackluster on the surface, it is likely to result in at least a 5.2% yield on cost in five years from now.