Starbucks’ valuation premium
Valuations in the food and beverage space are attractive presently as visible from their low one-year forward price to earning ratios coupled with rising price to earnings. Even though stock markets of China (FXI) and the United States (SPY) have surged in the past year, investors believe valuations of consumer discretionary stocks in these countries can rise further. With analysts’ forecasts of rising consumer spending in the next five years, these stocks have room to grow and their valuations could steepen.
As visible in the chart above, companies such as Tang Palace (1181), Xiabuxiabu Catering (0XI), Tao Heung Holding (0573), Want Want (0151) currently trades at low price to earning multiples. In the past one year, these stocks have generated healthy returns. Among the international food and beverage chains, McDonald’s (MCD), Whitbread (WTB), and Dominos Pizza (DPZ) trade at the steepest discount to its peers. Meanwhile, stocks such as Hung Fook Tong, Tingyi (0322), and Starbucks (SBUX) trade at expensive valuations.
Growth in all of the above-listed companies is a direct function of an increase in consumer spending. When demographics favor growth in consumption expenditure, revenues for these companies will grow, thereby leading to higher returns on the stock. However, market valuations for these successful companies are at levels which may not seem very attractive to new investors.
Generally, stocks trade at an average price to earnings ratio of 20-25x. Stocks trading lower than their average price to earning multiples or lower than the sector average price to earnings multiples attract investors’ attention because they’re considered cheap. The price to earnings multiple compares a stock’s price to its forward earnings per share. If a company trades at a high PE, it means investors are anticipating higher growth in the future.