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IFB129: A Sip of Starbucks Balance Sheet

Announcer:                        00:00                     You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern. To decode industry jargon, silence crippling confusion, and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

Dave:                                    00:36                     All right folks, welcome to the Investing for Beginners podcast. This is episode 129 tonight. Andrew and I are going to go back to the well, and we’re going to answer a listener’s question. We got a great one the other day, and Andrew thought this would be a great conversation for us to have with you guys, so I’m going to go ahead and read the question, and then Andrew will take the first stab at it. All right, so here we go. I have been practicing using the VTI Excel sheet and pick Starbucks since they are a large company that has been around for a while and doesn’t seem to be going anywhere. When I input their numbers into the spreadsheet, it put on a VTI of 1428 I see. They have more way abilities than assets. Their dividend has decreased from last year, and their shareholder equity seems to be in a negative. Yet when I read articles online, they say it as a good buy. How do you reconcile these articles with the data we are receiving through the VTI process. Thank you, and love all the content. Andrew, what are your thoughts on this?

Andrew:                              01:35                     Yeah, super good question. First off, and I think there’ll be a lot of fun to talk about Starbucks and take a deep dive into it. Just for kind of clarification for people who don’t know what the listener is talking about, we need to says VTI that stands for value trap indicator. It is a formula that I created and use on every stock I buy. And so basically it takes some of the financial numbers around the company and does some calculations and tells you generally whether it’s a good buy or not. So 1428, that’s a very high number in the range of VTI world. That’s definitely like in strong sell territory or at the very least, do not buy a territory. So I think you know it. It’s a great question and a great thing to think about. Because you have, you have on let, let’s start maybe with a disclaimer.

Andrew:                              02:36                     I love Starbucks myself. When I see a company like Starbucks, a brand like Starbucks, a cup of coffee in front of my desk, like Starbucks, everything about that makes me feel good, and it makes me want to be a part of that. And I think with a lot of the investments you’ll have, a lot of the stocks you buy and the businesses you want to have part ownership in, that’s like a great thing to have, and that’s a good piece and a good part of that. And then so it’s something you always strive for. However, at the same time when it comes to investing your hard-earned money, if you’re going to be smart, if you’re going to be conservative, if you’re going to try to take an approach that is maybe a little more boring by the little bit more heavy on facts, well then you’re going to have to kind of look at what is really going on behind the scenes and kind of think about, well, you know, appearances are just that appearances.

Andrew:                              03:33                     Can we kind of look behind the veil and see what’s going on? And so that’s why a lot of these types of accounting type terms and numbers are going to spit out by us. But the reasoning for that is because it’s really going to paint a better picture rather than like the question here said, you know, have a lot of articles online where they say it’s a good buy. I would challenge, you know, kind of first off, I would challenge the idea that you can’t find good articles on any stock you want to buy. So if you don’t believe me that there is a bullish argument for every single stock in the stock market, test it yourself, and you know, try to look up articles, and you’ll see that almost every stock has a general bullish bias when it comes to those are online.

Andrew:                              04:29                     And that’s the nature of the beast. I mean, Dave, I’m sure being somebody who even writes on articles of the type of articles that you write when you’re excited about a company is a lot more fun than the ones that aren’t. And so I think generally when you look on the internet more of the bullish articles tend to be published and promoted. Oh yeah, absolutely. Yeah. You go to, you look and seeking alpha, and yeah, there’s far more, bullish, you know, opinions on things than there are on the bearish. And they are, when you come across a company, you’re writing about them. It’s, it’s, it’s a way more fun to write about a company you think is, you know, doing well and is great and as a great investment as opposed to one day you think it is like me.

balance sheet

Andrew:                              05:14                     A kind of like your article about Dean foods. Yeah. Thanks. You rock up on the back about that one. Maybe it’s another topic for another day, but yeah, I claimed to be, I could be a Nostrodamus is I said no Nostradamus I have my 15 seconds of message on this fame with other, other cool. So that’s why I like looking at the numbers to, to hammer that point home. You can have ideas and thoughts and feelings and catch feelings for a company and the stock. And there can be so many different reasons, and some of them can be the dumbest reasons why you want to buy a stock. But when you have data, when you have numbers and when you have good context on those numbers, and you understand at least from a general standpoint what they mean, well then you have a much stronger base argument for why you’re buying stock rather than just, it makes me feel good.

Andrew:                              06:18                     And you know, justifying it in a million different reasons with a million different types of articles that are all saying the same thing. So why, you know, when, when you hear, when you hear words like that, you probably think that I’m about to put the hammer down on, on a company like Starbucks and I am. So let’s look at one of the things in this question. He says they have more liabilities than assets. So I will try to keep it simple, but at the same time, if you’re not well versed, and when I say, well verse like when I say assets or liabilities, if it goes completely over your head, I would recommend going back to our back to the basic series, which starts in the episode for the three, I think. And go through those articles or those episodes before you listen to this one.

Andrew:                              07:20                     So we looked at, and Dave and I both did this on the fly, which was kind of fun hearing his feedback and as I was going through it too. So we went back to one of our tools. We like to use quick fs.net and looked at a ten-year outlook at what’s going on with the business. And so from first glance, everything looks good. They have revenue that’s been growing double-digit over the past ten years. They have earnings per share; it’s grown over the last ten years at 27.4% compounded annually. That’s fantastic. And they have a high return on invested capital so that all looks great. And there were some share buybacks recently, so things seem to be churning and profits are, you know, flowing in. And I think that’s, those are all good things, so let’s not, let’s not discount that.

Andrew:                              08:23                     Now, the potential problem was when you get to the balance sheet. So for me, when I look at the stock or a company I want, I think any investor probably wants a good income salmon. And I think a lot of investors stop there. And so that’s why using a tool like the VTI can be helpful because it takes you a step further than that. And so where maybe more investors don’t look at the balance sheet or give it much credence, I think we can do ourselves a great favor by doing some of that ourselves. So what, what we see is more liabilities than assets. And what’s interesting is it’s wasn’t always the case. So from 2017 to 2018 is really where the liabilities ratcheted up. And then from 20 2019 is when liabilities went negative. And so it’s, it’s at a point like this where you kind of wander and you want to understand why, like, why, why did this happen, what happened?

Andrew:                              09:33                     And is it problematic, or is it something that we’re okay with as investors. So, again, as Dave and I were looking, we noticed longterm debt jumped up a lot from 2017 to 2018. Went from about 4 billion to about 9 billion. So that’s almost a three X jump. So that’s a lot. Just from that alone, you can kind of argue, okay, while it seems like a lot of this growth is being fueled by debt or at least there, there is a lot of a debt, a lot of debt accumulating. And so, you know, what’s the adage like spend money to make money. But that’s not always a great long term strategy for a company. So that kind of raises a red flag when you look at that. The second thing that stood out was one of these rows here in the bouncy is called deferred revenue.

Andrew:                              10:36                     So I don’t want to get super deep into deferred revenue. There’s a lot of different reasons why a company could have that liability. What we did is we pulled up the 10 K for the company. What I did was I just did like a search inside the document, and I looked for deferred revenue and found it in the tank and found the explanation for it. So what Starbucks did in that time frame is they struck a deal with Nestle. And so, you know, Nestle the chocolate company and so they had some royalty agreement where basically Starbucks got paid upfront and then there they, they agreed to let Nestle sell some other products and then Starbucks gets a royalty from those sales. And so they got paid a substantial amount of cash upfront. And then that’s like, and trying to like, break down the accounting jargon and make it simple. You kind of like a, you make a transaction, and you spread it out over many years instead of just one because this is going to be an ongoing thing, right? They’re going to be receiving royalty payments consistently, but they got some of it paid up front. And so you need to reflect that, but you can’t just put that all in one year because this is ongoing. Does that make sense at all?

Andrew:                              12:12                     Yes, it does. Okay. So that’s in like the most simplified way I can try to explain it. That’s that accounts for a lot of the reason why deferred revenue went up so high. And then when you also look at the balance sheet, you see cash in the balance sheet went up high too. And so it went from 2.4 billion to 8.7 billion. And that probably has to do with the Nestle thing too because like I said, they got paid upfront, so they had their assets shoot up, but they also had their liabilities shoot up as well. And so, you know, what are, I guess before I move on, what are your thoughts on that, Dave? As far as like, we, we, we see assets go up, but we saw liabilities go up more. Whether, whether your initial thoughts when as we bring it with the context of, okay, this is the whole Nestle thing that is affecting some of it.

Dave:                                    13:16                     Well, I, you know, when we were first looking at it, you know, I guess the first thing that I always think of is, you know, what are these numbers? What story are these numbers trying to tell me as I’m looking at them? Because you start looking at them from left to right. You know, he started at the beginning and you kind of look at him, and you see that you know, by, and large everything is growing. And when you looked at the first page of the summary, and everything was jumping out at you like really nicely, wow, these are all, you know, huge, you know, the revenue growth and earnings growth and you know, the return on equity to return on assets or all those things were just, you know, monstrous. You know, as I said, I’ve been working with banks a lot lately and so everything is so much smaller, but you know, they’re, they’re far more conservative in their gross because they’re so regulated and they’re looking at a company like Starbucks, which is not regulated. It’s like, wow, this is awesome.

Dave:                                    14:09                     But then one thing that I did notice was the price to book was negative. And I thought, huh, okay, that’s, that’s something that bears investigating. And I guess for me, when I look at these things, it’s, Trying to find answers to the questions. And so as you and I were going through this, we were both working at the same thing, and both are commenting on the same ideas of, you know, this is where this goes, and this is where this goes. And this is like, you know, like I was looking at the longterm debt and it jumped, you know, like you said, from roughly, you know, 4 billion to 9 billion. And then from there even up to 11.1 billion the following year. So it’s almost quadrupled in three times in two years.

Dave:                                    14:58                     Would we do to answer questions like why, what, why, why did that do that? And then we saw the deferred revenue part of it, and we both asked the same question, what is that? Where did that come from, and so using the 10 K as another tool to help you investigate why these things are. And that’s what kind of to me is the fun of this is trying to figure out why do these things happen and, and where are they going? Because you know, looking at the numbers just by themselves, sometimes it doesn’t always tell you the whole story. And sometimes you have to go back and look at words to help explain what’s going on.

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Andrew:                              15:47                     And I, so here’s, here’s a thought, right? Let’s take this thought process there. W you keep asking, you know why, why? And I love those questions. So let me ask the, let me break the third wall and ask the hypothetical listener who’s on the other end of this. You know, why, why are, why are Dave and Andrew so concerned about a company almost tripling their debt in two years? And why are they so bearish on a company that admittedly is growing a very high rate? Right? So, right. If we, if we take that three years like timeout period and we, we think so the company’s growing this big, their dad’s growing this big, what’s the big deal? So like invest in like wall street is seeing this growth and so they are, they’re getting excited, and when they look at the income statement, they’re seeing profits and revenue growing at such a high rate of speed.

Andrew:                              16:52                     So as they buy into the stock, they’re buying expecting that to continue. And at the same time, when you have the debt behind it also, I’m sorry about that. You have the debt kind of like underneath the surface also growing at such a high S at such a high rate, well, you’re going to have to have the debt continue to increase in order to get like, okay, we don’t know 100% whether that’s going to be the case, but I think it’s safe to say if it took them kind of tripling their debt to get that kind of growth to get the next stage of growth up ahead, it’s probably going to hurt and it’s going to be really hard to get to maintain that growth unless you’re also growing that debt. And the problem with growing debt is it the more of it that accumulates it’s like compound interest, it’s like negative compound interest.

Andrew:                              17:51                     And so, okay, let’s take kind of a more optimistic viewpoint. It’s like, well, maybe the company can kind of slow down on how much debt they’re taking on, but if that growth was fueled by debt and you take the debt away, so maybe the growth gets lower. And so as an investor, maybe you’re fine with that. Like you think, Hey, the business can kind of slow down and growth. The problem is when you’re buying into a stock like that now, and investors and wall street was buying into that. Now they’re going to all get very upset when that doesn’t happen. And so they’re going to draw their money out. So whether you as an investor are okay with them getting lower growth than what they’ve seen, chances are a lot of wall street isn’t going to be okay with that.

Andrew:                              18:39                     And so if you buy into a stock like that, the returns will be, I mean it’s not, it’s never guaranteed, but there’s a big chance that those returns are not going to look very pretty when those types of things come out. And so if you really try to analyze what are the possible situations and what are the possible fallouts you could have growth continues, and debt continue, you know, how long can you continue to have that grow, that debt multiply upon itself before the interest payments become so large that, you know, it just bankrupts the company. I don’t care how much money they make. So you have to kind of keep that in mind and think about an investor, you know, investors in wall street are looking at a stock and they’re expecting a certain thing. And so if you take that thing away, it’s going to crater the stock price.

Andrew:                              19:31                     And that’s the situation that we would like to keep investors from. And that’s a big reason why when we talk about either valuations or the balance sheet like we are now with the debt situation. That’s why we at least I tend to try the error on the side of margin of safety, emphasis on the safety because I don’t want to get burned by wall street, you know, the fickle Mr market kind of moving in and moving out so rapidly and really hurting returns over the long term. Yeah, I would agree with that. When you think about

Dave:                                    20:09                     Why do we get, why do we get so wrapped up in the negative part of some of these aspects, like the debt growing so much? When you think about debt, two things can be super negative for the company. Number one is that’s what weeds too, you know, most companies going bankrupt is when they got too much debt, and they can’t pay it back. Just like us personally, we buy too much stuff based on our credit, and then we lose our job, or we start making less money, or it just reaches the saturation point where you just can’t pay it back fast enough because the interest is compounding so quickly that you just can’t overcome that you can’t get under, can’t get over that mountain to, to pay it down. The same thing happens with a company. You know, eventually, there will reach a tipping point where you can only borrow so much to keep increasing the growth and everything that you read.

Dave:                                    21:12                     When you talk about growth, it can’t last forever. It just will not. It’s as physically impossible to last from now until infinity at some point. Every company goes through life cycles, I guess, is the best way of putting it. And Starbucks is going through a growth spurt right now, but eventually, it’s going to reach a period where it’s going to quote-unquote plateau, and it’s going to be more of a mature type of company, quote-unquote. And at that point, it can’t keep borrowing to try to generate any growth because now it’s either got so much debt that it’s got to start paying that back or they’re going to run into bigger problems. And we think about it from a monetary aspect. The more money you borrow, the more interest you pay. And that interest gets reflected on the income statement.

Dave:                                    22:05                     And it’s one of the expenses that gets eaten up by the income that you make. So if you’re, if your revenue starts to shallow, shallow, and slow down, you’re, and you still have that high debt, you’re, it’s cutting into your earnings, and that’s going to affect your earnings per share. And you can only buy back so many shares to offset that. And that’s where debt can become a big, big burden on companies. And so there’s nothing wrong with having debt and having it under control is the bigger issue. And that’s why Andrew and I are always very anti-debt which, because just like in our personal lives, in the business world, it can, it can produce wheat to your downfall and there there are so many other little aspects that are contained within it that you have to be considerate of. And when you see a company like Starbucks, which is you know, a very well known name, arguably one of the better brands out there, it when they’re taking on that much debt that quickly, that scares me. Even though all the other growth metrics are fantastic, but like Andrew was saying, wall Street’s not going to look that deeply into that.

Andrew:                              23:26                     They’re just going to see, Hey, earnings per share, hi, huge, awesome, you know, return or you know, all this great revenue, but what’s driving that? And they’re not going to look at that when they, and if they do start noticing that, then they may start chipping away at the share price and it can hurt You when you’re investing. But, you know, losing all your capital and investment when a company goes bankrupt, I’m not saying Starbucks is going bankrupt, but you get, you get where I’m going with that. So those are things that you have to keep in mind whenever you’re investing in a company at all. Yeah, I agree. Just an example of what you were saying, where a company could be growing a lot, you have a lot of debt, and that comes back to buy them. Enron, I featured them in my VTI book. They had fantastic growth metrics. They were on the fortune 500 lists for top whatever innovative companies and had great earnings per share growth, revenue growth, but the crazy amount of debt. I don’t think Starbucks is that like Enron level type of debt. And even in like you can you compare their longterm debt to you know, like the standard kind of EBIT.

Andrew:                              24:46                     You can, you compare debt earnings and, and they’re at a reasonable rate. You compare it to things like balancing the equity. Maybe it’s, it’s a bit high obviously, but it’s, that trend is really what’s more concerning and that Southern jump makes you kind of like lift your eye. And so, you know, coming full circle to, to the question about liabilities versus assets, that’s a big reason. And that’s where it started to shift first. Starbucks didn’t always have liabilities more than assets. They used to be the other way around, but it started the trend flit in this period that we’re discussing, which is 2017, 2018, and 2019. And that’s why those things are there. There’s also the last thing was like retained earnings dropped, and I dug into the 10 K and found that out. And I think it’s very boring, but just know that like if you can do, like if you run into an accounting term and you don’t know exactly like where the figure that you can go into a tank and kind of search for in generally there’ll be notes in there and you can kind of figure that out.

Andrew:                              26:07                     So that’s kind of why that, that’s like where, that’s what I see when we look at Starbucks when we look at the numbers, and it sounds like the listener too, that’s, that’s the big thing that they come up with. Kind of the big conclusion was like, Whoa, there’s something weird here with the balance sheet, and it’s throwing off the VTI. So whether that turns, you know, whether the next two, three, four or five years of Starbucks are going to be great, whether they’re going to be bad, I don’t know. And I honestly don’t care, and I’m not going to try to make a stand one way or the other. What I will say is yes, it’s obvious that the VTI is flagging this as a do not buy, do not buy. Do not buy and so I’m not buying. Is there a chance that I’m missing out on the great stock?

Andrew:                              27:01                     Yes, there is. But you know, this is something that you have to kind of pick your battles when you go, and you start buying stocks and figuring out what you want to invest your money in. Because yes, Starbucks is a great business, it has a great brand and it’s growing earnings and revenue. But that’s not always, that’s not always the big picture. And you could say that about most companies on the stock market. And so for you, the investor, you have to decide how much risk am I okay with how much kind of how firm is the ground I want to stand on when it comes to these stock investment choices that I’m going to make. And what is that firm foundation going to be? Going back to what I said in the beginning, is it going to be? I’m going to buy the stock because I like their coffee, or I like the color of their logo, or is it going to be on something more substantial?

Andrew:                              28:01                     Like, I don’t buy stocks with negative shareholders equity because that makes me nervous because when, when the company has more assets or lower debt, you know, that makes me more comfortable with the business. So those are the type of trade-offs you have to find and kind of make for yourself. And as somebody who promotes and generally encourages buying individual stocks, I really, really hope that investors are staying more on the cautious side and Erin more on that side rather than trying to be super risk-taking, especially the more important this money is to you and, and you know, the, the harder you worked for it, and you have to understand that the nature of the beast is missing now on some great stocks. So I like to think of it like if any of you like going to the state fair and getting really, really greasy on healthy food, if you go to the state fair and you get like something that tasted super, super good and then you go home, do you go home and then start thinking about, man, there was like 99 other greasy variants of food that I could have had, and I didn’t have, and now I’m upset about it.

Andrew:                              29:26                     Do you go to the fair and try the all 100, you know, or is it something where you’re just hoping for a good time, and then you’re happy even if somebody else may be found a better funnel cake than you did. So, really how is that any different from our investing? And so if you, if you’re kind of, you have to put yourself in that mentality a, and that’s a very important part of being a more conservative kind of margin of safety type investor. And be also understand that there are a lot of good sides to that. You know, you could pick, I could pick five different companies with growing revenues, right, that have like super trendy brands and cool businesses. But if you look across the landscape, look at even the last IPO is look at how Uber has been an absolute disaster.

Andrew:                              30:27                     Spotify has tanked. Now we’re starting to see the cannabis stocks fall and when we say fall there, they’re falling hard. And so, you know, why do you have other types of stocks where they don’t fall as hard and why do you have other stocks that kind of slowly build wealth over time? And it’s generally because of these types of fundamental things that you can find in the balance sheets. You can find in the income statements in it; it can be all revealed in the numbers. And so if you’re playing a numbers game, trying to spread your risk out, yeah, you can kind of try and kind of pick the stocks and the companies you like. But if you’re going more based on a numbers approach, I think you’ll be much happier with the numbers in your results when you do such a thing.

Andrew:                              31:18                     Because it comes down to kind of the basics of that. And it’s generally easier to make money when you have more assets as a company. It’s easier for less leveraged companies to survive during hard times. And you know, it’s just a lot of these types of general principles, and nobody likes to talk about, they stay true over the long term. And so it’s, it’s, it’s airing on that and, and being more cautious and picking the stocks that are still great businesses still have great brands and are still very, very popular, but maybe they have a much better balance sheet. I think that’s a much better way to go. I would agree with that. I think the only thing that I would, I guess add to that would think of it as we’ve talked in the past or Buffet talked a lot about thinking about buying stocks is like swinging at a baseball. You don’t have to swing at every single pitch. You get. And so even though you may love a company like Starbucks or a Netflix or somebody along those lines and you use their products, it doesn’t always mean that that may be the best investment for you. And it comes down to is your risk

Dave:                                    32:39                     Tolerance, and what can you handle. And if you can handle something like a negative shareholders’ equity or growing debt for a long period, then that’s probably the way to go. It isn’t for Andrew and me, that’s not the way we operate. I want to go to bed and not stress about, you know, Oh my God, I have all this money in Starbucks, and all these things are going on with it, and it scares the crap out of me. That’s not the way I like to operate. And I don’t think Andrew does either. And I think the way that you should look at this is when you are looking at any company, yeah, there’s a chance you could, you know, miss out. You know, the FOMO, the fear of missing out is a very strong desire and drive for us for a lot of different things.

Dave:                                    33:30                     But when you’re investing in using your hard-earned money, I think using the numbers as a way to tell a story for you and basing your decisions on those because they aren’t going to lie to you, and they are going to tell you really kind of what’s going on and what you’re comfortable with. And like buffet says, you don’t have to swing. There’s no, there are no three strikes, and you’re out in the stock market. You see a company you like; you look at all the fundamentals, you look at all the numbers, and everything lines up with all the different things that you are trying to measure it on, and that works. Then you know you can take a swing and buy, but if there’s one thing in there that you’re like, eh, Nope, then you can move on and move onto the next thing. Does it mean you might miss on it on the next Amazon or Apple or whoever? Yeah, there’s that possibility, but you’re going to win more often than in the long run by sticking to your principles and your investing fundamentals and going with that as opposed to just swinging wildly and trying to hit every single pitch for a home run. That’s not the way to success.

Dave:                                    34:39                     And I’ve found plenty of stocks with great growth, you know, great revenue growth, double-digit earnings graph, and they don’t need to be levered to the help. They don’t even need to have a ton of liabilities either. You, yeah, they can be more expensive sometimes, but if you, there’s patient, you kind of pick your spots and you keep an eye out, you’ll find great companies. All right folks, we’ll, that is going to wrap up our discussion for this evening. Again, thank you for writing in and telling us some great stories and giving us some great questions. This is a lot of fun for both of us to be able to talk about all these things, and hopefully you guys were in a finger or two from our conversations. So without any further ado, I’m going to go ahead and sign this off. If you guys are enjoying the show, please go ahead, subscribe so you can get more great information from Andrew and me, and without any further ado, go out there and invest with a margin of safety. Emphasis on the safety. Have a great week, and we’ll talk to y’all next week.

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