Starbucks and the Pitfalls of Investing in Turnaround Stocks

• Waning confidence in Starbucks’ turnaround has led to a sharp sell-off in recent months.

• Starbucks’ international exposure can be an advantage, but it also makes the company more difficult to turn around.

• Starbucks has taken on debt with little earnings growth to show for it.

• 10 stocks we like better than Starbucks ›

Starbucks (NASDAQ: SBUX) finished February above $115 a share — knocking on the door of a new all-time high. But at the time of this writing, the stock is around $81 a share. That’s a brutal decline in a relatively short period, especially since the major indexes have recouped much of their losses from early April tariff turmoil.

Here’s what investors can learn from Starbucks’ struggles, and the challenges of investing in turnaround stocks.

Starbucks investors have been on a roller-coaster ride over the last few years. Sales plummeted during the pandemic’s height as the once-reliable traffic from work commutes and travel ground to a halt.

Starbucks recovered partly due to its durable rewards program and growth in mobile order and pay, and the stock hit an all-time high in summer 2021. But behind the euphoric gains was a company struggling with its identity.

Founder and longtime CEO Howard Schultz came back as interim CEO in April 2022 and encouraged the company to get back to its roots as a “third place” away from home and work. Laxman Narasimhan was tapped as CEO in April 2023, but only lasted until August 2024, when Starbucks poached Brian Niccol from Chipotle Mexican Grill. Niccol was instrumental in turning Chipotle around. There was so much optimism that he could do the same at Starbucks that the stock soared 24% in a single day in reaction to the management news.

Investing in turnaround stocks implies that problems are solvable. It can work wonders when there’s a great underlying business with a strong brand that has struggled due to managerial missteps or operational inefficiencies, rather than something being fundamentally wrong.

Many of today’s greatest companies underwent periods of slowing growth when pivotal decisions had to be made to redirect the business. Apple did it with product innovation when Steve Jobs returned in the late 1990s. Netflix pivoted away from mail-order DVDs and transitioned to a pure-play streaming company. Amazon‘s decision to bet big on cloud computing through Amazon Web Services was a huge win, as AWS is arguably more valuable than the rest of Amazon combined. Meta Platforms, then Facebook, bought Instagram in 2012 for $1 billion. Today, Instagram may be worth more than Facebook. Alphabet, then Google, bought YouTube in 2006.

Starbucks is no stranger to reinventing itself. Rapid expansion in the 1990s and 2000s led Starbucks to become fairly saturated in the U.S. Starbucks decided to expand internationally, the crucial decision coming in 1999 when it opened its first store in China. China was meant to be Starbucks’ eureka moment — like the iPhone was for Apple and streaming for Netflix. On paper, it’s been a game-changer.

Starbucks closed fiscal 2024 (ended Sept. 29, 2024) with 21,775 international stores (including 7,594 in China), compared to 18,424 in North America. But Starbucks makes 82% of its net revenue from company-operated stores.

Starbucks finished fiscal 2024 with 21,018 company-operated stores — so roughly half of total stores are company-operated. But 89% of company-operated stores are in North America (11,161) and China (7,594). All of Starbucks’ China stores are company-owned and operated, which isn’t the case in North America. This makes China extremely important to Starbucks’ bottom line.

In fiscal 2024, Starbucks opened 790 net new stores in China compared to 533 in North America, making China its fastest-growing region.

Expanding internationally can be highly effective for a company with a clear identity. But Starbucks doesn’t have that right now. Under Niccol’s leadership, Starbucks is working to reduce food and beverage selections and “reintroduce Starbucks to the world” with expensive marketing efforts. The problem is that Starbucks is so big that it’s beyond the experimental phase.

Starbucks isn’t an easy company to turn around. Customer expectations vary based on geography, so a one-size-fits-all approach is unlikely to work. Some customer bases may not respond as well to the brand characteristics Starbucks is leaning into, such as the traditional coffee house vibe and “third place.” Starbucks must be careful that its new ideas position the company to thrive in North America and key markets like China and Japan. In other words, the strategy needs to be a new positive for the company, not just restore its brand in one region.

Financial results are the best way to measure the turnaround’s success over time. But on the last earnings call, management encouraged investors to focus less on earnings per share (EPS) and margin declines and more on the intangibles like the brand and customer satisfaction. Starbucks’ turnaround will take time and come at a high cost, which tests investor patience.

As you can see in the following chart, Starbucks’ operating margins are at a 10-year low, excluding the brief pandemic-induced plunge. EPS has also fallen back close to pre-pandemic levels. So even though revenue is up, lower operational efficiency is straining EPS growth.

As much as Starbucks wants investors to focus on the big picture, earnings do matter. Starbucks has been increasing its dividend every year since it first implemented it in 2010. Its dividend per share of $2.44is 88% of trailing 12-month EPS. A healthy payout ratio is typically when the dividend is around 50% to 75% of earnings.

What’s more, Starbucks’ net long-term debt has skyrocketed in recent years — roughly doubling from pre-pandemic levels. Granted, Starbucks had very low debt pre-pandemic, so its debt is still not out of control for a company of its size. Still, taking on debt without growing earnings is a recipe for financial strain, and having debt makes it even harder to execute an already complex turnaround.

Starbucks’ turnaround struggles illustrate the importance of having strong leadership and a strategy that can be implemented across a global and complex network of stores and supply chains. It could realistically take years for Starbucks to return to meaningful growth, reduce its payout ratio, and cut down its debt level. But the turnaround is showing signs of progress.

Given how beaten down Starbucks is, investors who are confident in the brand and are looking for passive income may want to consider buying the stock. Starbucks yields a hefty 2.9%, a sizable opportunity for income investors confident in the company’s eventual return to growth.

However, investors who are more skeptical about the turnaround may prefer to keep Starbucks on a watchlist. The stock will likely remain highly volatile until measurable results show that the turnaround is working.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Chipotle Mexican Grill, Meta Platforms, Netflix, and Starbucks. The Motley Fool recommends the following options: short June 2025 $55 calls on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.

Starbucks and the Pitfalls of Investing in Turnaround Stocks was originally published by The Motley Fool