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3 Green Flags for Starbucks Stock, and 1 Red Flag

Starbucks (NASDAQ: SBUX) has taken it on the chin lately. The company has dropped 27% over the past year, far worse than the Dow Jones Industrial Average's 6% decline.

Supply chain shortages, a looming recession, and inflation certainly haven't helped Starbucks' share price recovery, yet they weren't the highlights of the company's fiscal third-quarter results, which ended July 3 and were reported on Aug. 2.

Let's examine the quarter's highlights and the main concern that weighed on Starbucks' solid performance.

Image source: Getty Images.

1. Starbucks is becoming a worldwide brand

This coffee giant is primarily known for its scale in China and the U.S., which remained true in Q3. Revenue from these two regions combined to represent 75% of total revenue during the quarter. However, Starbucks saw plenty of success from its operations outside these two countries.

Excluding China, Starbucks saw international comparable-store sales increase in the double-digit range, and every single major market in the international segment (excluding China) saw sales growth in Q3. In Japan -- Starbucks' third-largest market -- comparable sales accelerated to their highest point in the year.

This quarter was a testament to Starbucks' strengthening brand worldwide. Not only does the company have operations at scale in China and the U.S., but around the world, making it unique in that it might be the only coffee company that has a globally recognized brand.

2. Starbucks loves its investors

Another reason to get excited about investing in Starbucks is that it gives back to investors (a lot). Over the past three fiscal quarters, the company has bought back over $4 billion of common stock and paid out $1.7 billion in dividends.

SBUX Shares Outstanding data by YCharts

These shareholder-friendly actions aren't one-time occurrences, either. Over the past decade, Starbucks has cut the number of outstanding shares by roughly 24% to 1.15 billion. The company's payout ratio is also near 54%, meaning that for every dollar of earnings the company produces, it gives investors almost $0.54 as dividend income.

3. Success in the digital game

Another factor that is becoming increasingly significant for Starbucks is its digital operations. Enabling digital ordering is influential for fast-casual restaurants and coffee chains because it can improve profitability and efficiency. After all, if a consumer can easily order online, that frees up a barista to do other things to grow efficiency and sales.

It can also help with customer engagement and loyalty, which are vital in an industry where switching costs are low for consumers, like the beverage space. As if there weren't enough reason to focus on digital ordering, these orders also tend to drive higher member spending.

Therefore, seeing the number of active Starbucks rewards members jump 13% year over year to 27.4 million is encouraging.

1 red flag: The China knife cuts both ways

Despite a widely positive quarter for Starbucks, one segment slumped: China. Unlike many U.S.-based brands, Starbucks has thrived in the country. It has over 5,700 stores in China, and in the last fiscal year, Starbucks generated almost $3.7 billion in revenue from the region.

However, the country's COVID-19 lockdowns have taken a toll on Starbucks. Comparable-store sales in China tumbled 44% year over year in Q3, dragging total international comparable-store sales down 18% versus the year-ago period -- despite the company's good execution in almost all regions.

The bottom line is that operations in China are risky. Starbucks has been a beneficiary of the thriving Chinese economy and rising consumer demand in recent history. That said, the economic environment is hard to predict, meaning companies operating in China can face wild volatility. Q3 was a reminder of this fact.

Should you buy Starbucks now?

If you're not willing to stomach the uncertainty that comes with operations in China, Starbucks might not be for you. Still, the company has healthy exposure to the region, and if you don't have any other exposure to China via foreign stocks, this might be all the exposure you need.

Starbucks has slowly developed one of the strongest brand names in the world and turned it into a thriving global business. If you're looking for a stable, steadily growing stock to balance out higher-growth investments, Starbucks could be for you.

What's more, you can get compensated nicely for owning the company through its aggressive dividends payments and stock buybacks. And at a valuation of 25 times earnings -- far below that of rivals in the coffee and restaurant space -- you're getting the stock at a fair multiple.

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Jamie Louko has positions in Starbucks. The Motley Fool has positions in and recommends Starbucks. The Motley Fool recommends the following options: short October 2022 $85 calls on Starbucks. The Motley Fool has a disclosure policy.


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