Starbucks’ continued growth merits spot on watch list

There seems to be a Starbucks (Nasdaq: SBUX) on every corner. Does it deserve a location in your portfolio, too?

Along with its flagship coffee brand, Starbucks also owns Tazo teas, Seattle’s Best coffees, Evolution Fresh and VIA instant coffee – and it’s buying Teavana, too. Starbucks is also challenging popular Keurig K-Cup at-home brewing machines with its Verismo.

It’s easy to feel good about Starbucks. During the economic downturn of 2008 and 2009, founder and CEO Howard Schultz famously refused to slash the health insurance he offers to most baristas, even though it was costly.

Days of heady growth in the United States may be waning, with 71 percent of its 18,000 global locations in the Americas. But Starbucks has lots of room to grow abroad.

Consider that Japan and South Korea combined have almost five times more Starbucks locations than China, even though their combined population is less than one-seventh of China’s. Even without a booming presence in China, Starbucks was able to increase revenue by 14 percent over the past year, and upped its dividend 28 percent, too.

With a price-to-earnings (P/E) ratio near 30, Starbucks isn’t cheap. Give it a look, though, and perhaps add it to your watch list. (The Motley Fool owns shares of Starbucks and its newsletters have recommended it. It owns shares of Teavana, too.)

Ask the Fool

Q: Who sets stock prices? – J.N., Seattle

A: A company’s stock price isn’t set by anyone. Rather, once shares have been sold by the company to the public (either via an initial public offering or a secondary offering), they trade fairly freely in the stock market.

It’s not unlike trading cards, which are valued at what people will pay for them. If demand rises or falls, so do prices. That’s why, if there’s bad news about a company, its stock will usually soon be worth less – and vice versa.

My dumbest investment

My dumbest mistake was shorting Amazon.com when its price-to-earnings (P/E) ratio was around 200. No matter what its P/E is, there always seem to be buyers. – O.W., online

The Fool responds: It’s reasonable to steer clear of sky-high P/E ratios, as overvalued companies can be more likely to fall than to keep surging. But there’s risk in actually putting money on the expectation that the stock will fall. Remember that a P/E ratio is just that – a simple ratio, dividing a stock’s current price by its trailing year of earnings per share (EPS). Amazon’s P/E has soared about 3,000 recently, because its EPS fell as it invests heavily in its future. The company’s forward P/E, based on expected EPS for next year, is considerably lower, at 98.

Take P/Es into account, but also assess how much you expect a company’s value to grow from current levels, factoring in its financial health, competitive strengths and potential. For many years, Amazon has been deemed overvalued, while its stock has kept growing. (The Motley Fool owns shares of Amazon and its newsletters have recommended it.)