(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his clients own shares of SBUX.)
Investing is all about perception versus reality. Earnings growth is seen as a positive, and the more growth investors see, the higher the premium they are willing to pay for a stock. But at some point, reality hits, and that perception can change very quickly. A recent example is McDonald's Corp. (MCD) and Starbucks Corp. (SBUX).
Right now, it appears that investors are probably overpaying for McDonald's perceived growth, while Starbucks' real growth has not been recognized. When investors perceive that Starbucks is growing again, the stock will probably begin to rise. And when investors realize they are overpaying for McDonald's perceived growth, shares will likely fall.
McDonalds and Starbucks stocks are perfect examples of perception versus reality. McDonald's is up by 37 percent in 2017, while Starbucks is up only 3 percent this year. McDonald's revenue is expected to fall by 7.8 percent in 2017 to $22.69 billion, while Starbucks just reported fiscal 2017 revenue growth of 5 percent to $22.39 billion.
McDonald's earnings are expected to grow by 14 percent to $6.52, while Starbucks' earnings in fiscal 2017 increased by 7.9 percent to $2.06 a share. The result has been significant stocks gains for McDonald's, and minute gains for Starbucks.
The valuation of each stock provides some context. McDonald's trades at a one-year forward earnings multiple of nearly 24, while Starbucks trades at a one-year forward multiple of 21.5.
Meanwhile, McDonald's trades at 6.5 times one-year forward sales, while Starbucks trades at 3 times one-year forward sales. (See also: Differences Between Forward P/E And Trailing P/E.)
The perception is that McDonald's is delivering strong earnings growth, but investors are ignoring its declining revenue and revenue forecasts. Revenue for McDonald's is expected to decline by nearly 12 percent to $20.01 billion by 2019.
The company's earnings are projected to climb 16 percent, to $7.58 a share, over the next two years. If McDonald's is growing earnings despite falling revenue, it meansthe market is paying a premium for a company that is likely only buying back shares and cutting expenses.
The reality is that Starbucks shares have underperformed mostly because the company's valuation got too high in the past, and investor expectations needed time to come down.
For the most part, after two years of no stock gains, that reset has happened. Starbucks is expected to grow earnings per share by 31 percent from fiscal 2018 to 2020 to $3.04, while revenue is expected to increase 20 percent to $29.50.
Investing is genuinely all about perception versus reality.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.