The S&P 500 is up 25% this year and continues to hit new highs. It’s a time of confidence in the economy and excitement in the future. However, it means that it’s getting harder to find great deals in the market. As the market goes higher, valuations are starting to look inflated.
Warren Buffett recently reiterated his approach to investing as saying that he buys wonderful businesses at fair prices instead of fair businesses at wonderful prices. Investors should take heed and find those excellent businesses trading at fair prices instead of focusing on the incredible deal. Over time, your investment in these kinds of businesses could skyrocket.
Consider coffee chain Dutch Bros (BROS -0.62%). Dutch Bros stock is still 36% off of its highs at the time of this writing, and it trades at a reasonable valuation. But it’s going places, and now is the time to buy it.
Coffee that hits the spot
Dutch Bros is still a small coffee shop with 950 stores across 18 states, not even half of the states in the U.S. However, it’s opening stores at a brisk pace, and it has moved from its West Coast base across the Southern U.S., picking up fans in different regions. It opened 38 new stores in the 2024 third quarter and is on track to open 150 stores in 2024. Longer term, it plans to open 4,000 stores over the next 10 to 15 years.
It offers a different spin on coffee than Starbucks and other coffee chains. It has fine-tuned its message over its 30-year history, and its down-to-earth fun culture, lower prices, and focus on speed and service are hitting the spot with its customers.
As a young company in growth mode, it continues to demonstrate higher sales each quarter, with the combination of new stores and increasing same-store sales contributing to the mix. These days, new stores are bearing more of the weight. The average American still feels the impact of inflation in their wallet, and they may not be splurging as much on a custom beverage. That’s showing up in pressure on same-store sales. In the company’s favor, its lower prices can bring in more business from customers who choose a drink based on price point.
In the third quarter, sales increased 28% year over year, and same-store sales were up 2.7%. It had the highest same-store transaction growth in two years because higher comp increases have included price raises. This implies more people are buying more often, which is a huge win. Increases in same-store sales that only come from price increases are a worry.
Making the concept work
Investors usually see young growth stocks as risky. If they’re just getting started and aren’t profitable, they could never make it, and you could see your money disappear, even if it’s a great concept in theory.
Dutch Bros is making the leap from a great concept to a profitable venture. It has reported several quarters of profitability on a generally accepted accounting principles (GAAP) basis, and profits are growing. It’s not just a popular product, but one that can make money. Of course, the market is going to react positively, and Dutch Bros stock is up 77% over the past year.
It reported $21.7 million in net income in the third quarter, up from $13.4 million last year. Adjusted earnings per share (EPS) of $0.16 was way ahead of Wall Street’s expectations of $0.12.
Beyond the implication that Dutch Bros has created a viable company, the profitability improvements mean that the company’s growth is outweighing the capital expenditures needed for such an enterprise. Dutch Bros is growing carefully, ensuring that its formula is perfectly implemented in each new store and that new stores are vetted for maximum performance.
It disappointed investors last quarter when it gave an update that new store openings for the full year would be on the bottom layer of guidance, but that was due to a reorganization of real estate assessment based on new factors; it wasn’t chasing new store growth at the expense of value creation. Its new model of real estate is already leading to better results, and slower growth, in this case, means better, more profitable growth. It’s the right way.
You can’t time the market
Dutch Bros stock jumped a whopping 40% after the report, and it’s still going. At the current price, it trades at a forward, 1-year price-to-earnings (P/E) ratio of 87. That’s rich. Is it justified? It also trades at a price-to-sales (P/S) ratio of 3.8, which is reasonable. That’s why it’s often important to see valuation from different perspectives.
If you can zoom out and envision where Dutch Bros stock will be in five years, it looks like this is a reasonable price to pay and a great time to buy. Sure, you can wait for a better entry point or market correction. Or you can buy now, relax, and enjoy the rewards in a few years.
Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Starbucks. The Motley Fool recommends Dutch Bros. The Motley Fool has a disclosure policy.
