With £1,500 to invest, I’d be buying shares in Starbucks (NASDAQ:SBUX). I think that it would make a great addition to my portfolio right now.

Predictability

Buffett’s investment style involves looking for predictable business that will do well over time. It isn’t about trying to find stock that will double or triple within the next year.

Starbucks is exactly this type of company. With a dominant market position, growth is more likely to come steadily, rather than spectacularly. 

In my view, growth at Starbucks is likely to be driven by three things. The first is increased coffee consumption.

The US coffee market is forecast to grow at around 6% annually for the next few years. Since Starbucks has a dominant position in the US, I expect its sales and profits to benefit. 

Second, I expect the company to open new outlets, boosting its income. Buffett says that it’s best if a company doesn’t have to spend much cash to grow and I think this applies here.

Compared to other restaurants, Starbucks has relatively low costs associated with opening stores. This is because its outlets don’t need full kitchens and so have lower equipment costs.

Third, Starbucks has been buying back its own stock. As the number of shares decreases, the amount of the overall company’s earnings attributable to each share goes up.

Buffett has been effusive in his praise of Apple repurchasing shares. And over the last five years, Starbucks has reduced its share count from 1.47bn to 1.15bn.

The company paused its buyback programme earlier this year to invest in growth opportunities. But over time, I expect the number of Starbucks shares outstanding to decline.

Diversification

If I were investing £1,500 today, I’d be happy to invest it in Starbucks shares. I think that the stock has the hallmarks of a great Warren Buffett investment.

There’s a degree of risk that comes with investing the full £1,500 into a single stock. If I’ve misjudged the business, then I stand to see all of my investment underperform.

Importantly, though, I already have a fairly diversified set of investments. Buying £1,500 worth of stock in Starbucks would make the company around 2% of my portfolio.

I’m also invested in businesses like Aviva, Meta Platforms, and Southern Copper. As a result, adding Starbucks shares doesn’t leave me over-exposed to any particular region or sector.

If I didn’t already have other investments, I would be looking to invest part of the money and invest the rest elsewhere. But I don’t think 2% of my portfolio is excessive.

I’d therefore look to add Starbucks shares to my already diversified portfolio. I think it makes a lot of sense as someone looking to use the Warren Buffett method.

Strong demand and new projects

If I put the financials to one side to begin with, consumer demand should help to boost Starbucks shares. Despite the existing size of the business, it still managed to grow store sales by 17% during the quarter ending in early October. This was split between a 15% increase in transactions and 2% from the increased average ticket spend.

I think this goes some way to showing the resilience and longevity of Starbucks that should be carried over into next year and beyond. The business is still seeing growth and pursuing it. One metric that highlights this is that it opened 538 net new stores during the quarter. This puts the total store footprint at a record high of 33,833.

Added to this is the desire to push forward with new initiatives and not rest on previous successes. For example, it has launched a partnership with Amazon Go, enabling customers to go and pick up coffee in a store with no cashiers. This is still in a pilot phase at select locations, but it shows the vision for the future. If projects like this continue, then Starbucks should be able to stay relevant and not get stuck in the past.

Upside potential for Starbucks shares

As an investor, the above points are great, but I do also need to consider the finances. Fortunately, it’s good news here for Starbucks shares as well. For the full fiscal 2021 year, sales came in at $29.1bn, a growth of 24% year-on-year. This led to an improved earnings per share figure of $3.54, up $0.79 from the prior year.

One point I am a little disappointed on is the dividend yield, which sits at just 1.72%. As a mature business, I’d expect Starbucks to offer a much more generous dividend to keep long-term shareholders happy. In fact, if growth does stagnate in coming years, then the lack of a dividend could pose a real risk to the share price.

Another risk that’s worth mentioning is whether consumers will change their spending habits regarding coffee. The pandemic saw revenues drop substantially, as lockdowns forced people to make coffee at home. Although recent results suggest people are back in stores, buying coffee this way is much more expensive. If people start to become more conscious and brew coffee at home, it could hurt Starbucks.

Ultimately, I think the firm is performing very well right now. With new initiatives being rolled out, I think Starbucks shares could do well next year and so am considering buying shares.

Of course, stocks could pull back at any time. However, encouragingly, some experts believe the market could keep rising for a while. Wharton professor Jeremy Siegel, for example, believes stocks could keep rising until the US Federal Reserve moves to tighten rates. And he doesn’t believe that’s going to happen in the near term. “Enjoy this ride. It’s going to keep on going… toward the end of the year,” he told CNBC last week.

Here, I’m going to highlight three stocks I like for this bull market. I’d be happy to buy all three for my own portfolio today.

Diageo

One FTSE 100 stock I believe has the potential to keep climbing in this bull market is alcoholic drinks giant Diageo (LSE: DGE).

My investment case here is pretty simple. As the world reopens in the months ahead, people are likely to catch up with their friends and drink alcohol. As the owner of a wide range of top brands such as Tanqueray and Guinness, Diageo should benefit.

This isn’t just a short-term play, however. In the long run, Diageo looks well-placed to benefit from the ‘premiumisation’ trend. Increasingly, consumers are willing to pay more for higher-quality products.

Of course, if there are Covid-19 setbacks, my investment case may become obsolete. However, with the stock still more than 10% below its all-time highs, I think the long-term risk/reward proposition here is attractive.

Starbucks

Another stock I’d buy for this bull market is US-listed Starbucks (NASDAQ: SBUX). This is a stock star portfolio manager Terry Smith bought for his fund last year.

I think this company should do well as lockdowns are eased globally. People are going to want to catch up with their friends so Starbucks should benefit. “We are here for that great human reconnection,” CEO Kevin Johnson said recently. “Starbucks was built for this moment.”

However, Starbucks isn’t a cheap stock. Currently, it sports a forward-looking P/E ratio of about 40. This adds risk to the investment case. But I’m comfortable with the valuation as the company has historically been very profitable.

Smith & Nephew

Finally, I like Smith & Nephew (LSE: SN). This is a leading medical technology company specialising in joint replacements.

Smith & Nephew has had a tough year. That’s because during Covid-19 many elective medical procedures were postponed. However, I see this as a short-term setback. As vaccines are rolled out globally, elective procedures should pick up, boosting Smith & Nephew’s sales. This year, analysts expect sales to rise about 16%.

Looking further out, there’s an attractive growth story here. By 2030, it’s expected there’ll be 1.4bn people across the world aged 60 and over (versus less than 1bn now). This demographic shift should drive demand for joint replacements.

This stock could be volatile in the short term as Covid-19 cases fluctuate. In February, the company said there’s uncertainty regarding the timing and pace of the recovery.

However, I believe if I’m patient, I’ll be rewarded here. It’s worth noting that Barclays just raised its target price to 1,875p from 1,750p. That’s about 33% higher than the current share price.

WASHINGTON, DC — At the end of this month, Starbucks  (NASDAQ: SBUX.US) is likely to post a result that will draw little attention, but is intriguing for its larger implications: The company will overtake McDonald’s  (NYSE: MCD.US) for the first time in pre-tax earnings in Japan.  McDonald’s, of course, has struggled in Japan recently. Its 50-owned Japanese subsidiary recently announced that it was closing 74 stores, or about 2.3% of its total store count, due to declining customer demand. Starbucks’ demand arc in Japan is quite another story — the company has gone from zero to more than 1,000 stores in less than 20 years. 

The two businesses’ trajectories in Japan are emblematic of a more global phenomenon. On nearly every continent, McDonald’s is struggling to maintain its growth momentum, while Starbuck’s has seemingly effortlessly posted a recent annual growth rate of 11.1%. McDonald’s is dealing with a number of factors crimping its revenues, the most prominent of which is a sea change in consumer preferences, for higher-quality, fast-casual establishments over quick-service chains like McDonald’s. Yet recently, the company has zeroed in on Starbucks as a threat to its business. Here’s Chief Operating Officer Tim Fenton during the company’s most recent earnings call, discussing the last quarter’s problems and mentioning Starbucks but not by name:

“… we lost some share based on our insights to non-traditional competitors, cafés, and bakeries.”

As Bloomberg reported a few days after this call, internally, McDonald’s has challenged its operators to protect its breakfast segment by winning what it deems a “coffee war” with Starbucks.

Will McDonald’s wrench significant amounts of market share from Starbucks with this new push? It’s doubtful. But CEO Donald Thompson understands that sometimes, to push forward a big strategic objective, you need to humanize the objective and create a villain that your troops can rally around to defeat.

The point of appearing to go to war

In this case, the strategic objective is simply to increase coffee-driven visits in the U.S., as such visits usually occur at breakfast, which accounts for 25% of company revenue. The strategy is likely informed by the chain’s recent experience in Canada. In 2008, career McDonald’s executive John Betts took over the company’s Canadian division. Along with upgrading McDonald’s Canadian locations to a more contemporary aesthetic, Betts implemented a plan to draw more Canadians into McDonald’s outlets with coffee, because Canada, similar to the U.S., is a coffee culture. 

Most notably, McDonald’s Canada began giving coffee away for free, first running this promotion in 2009. The emphasis on coffee won over skeptical Canadians, and since then, coffee sales in Canada have tripled, and breakfast has seen double-digit sales increases for the last five years. As Betts archly stated in 2012: “When you change someone’s coffee habit, you have got them.” 

In the U.S., McDonald’s can’t expect to triple its coffee sales in five years by giving away free coffee. When Starbucks was but a single crammed location in Pike Place Market in Seattle, and the company’s global footprint existed only as a network of neurons in Howard Shultz’s brain, McDonald’s provided by default the most widely available retail cup of coffee in the country. Today, the landscape has changed irrevocably. What McDonald’s can expect by pushing a “gold-standard cup of coffee with every visit” is to regain traction with wavering customers.

As CFO Pete Bensen stated during the company’s most recent earnings conference call, “If we lose relevance in coffee, then we are going to lose the transaction which yields food purchase.” In other words, if the company can direct more of the legions in need of a coffee fix through its arches during breakfast, the rest of the transaction will fall into place. It’s interesting how well Woody Allen’s famous quote that “80% of life is showing up” applies to a simple and well-reasoned corporate strategy like this one.

Toward this goal, McDonald’s has quietly laid the groundwork for increasing the quality, supply, and promotion of its coffee. Last year, the company announced that it was investing $6.5 million to assist more than 13,000 farmers in Guatemala and other South American countries, to scale up volume of high-grade arabica coffee beans, as well as to assist small-scale farmers with sustainable agricultural methods.

As for promotion, the company’s well-publicized push into packaged coffee through its new partnership with Kraft might be construed as an attempt to compete with Starbucks in the retail grocery venue, but it’s more immediately about heightening coffee brand perception. It is betting that U.S. incentives such as its “$1 any size coffee” at breakfast, coupled with McDonald’s-branded coffee in grocery stores, will keep its coffee top of mind versus Starbucks and other competitors. If increased business at breakfast eventually leads to additional sales of packaged coffee, as well as more non-breakfast visits, the company will take it as a bonus.

A reaction from Seattle

How is Starbucks responding to McDonald’s sudden pressure on the coffee front? By ramping up its new breakfast offerings, of course. This month, the company is introducing four new premium breakfast sandwiches, with enticing names including “Slow-Roasted Ham and Swiss” and “Vegetable & Fontiago.” Tearing off a sheet from the McDonald’s strategy notebook, Starbucks will offer a free Grande-sized brewed coffee with the purchase of a breakfast sandwich from March 12-14. Of course, Starbucks also has a larger strategy in mind, which is to generate a larger transaction per customer. Yet it speaks to the importance of the breakfast market that given a few more disappointing sales quarters from McDonald’s, or any sign of Starbucks’ vaunted growth slowing, and these two giants could be headed for confrontation after all.