1 Retailer That Would Fit in Warren Buffett's Portfolio

By Markets Fool.com

Continue Reading Below

Source: Starbucks.

Warren Buffett has built one of the biggest fortunes in the world by investing in top-quality companies for the long term. While it's hard to know Buffett's next move, it makes sense to search for investment opportunities that would fit his investing criteria. After all, if a company is good enough for the Oracle of Omaha, it could also merit a place in your portfolio.

Starbucks is not of Buffett's holdings, but the company offers many of the characteristics that he appreciates in a business. Using Buffett's framework for picking great companies, let's dig into the coffee giant's stock and its potential over the long term.

Warren Buffett's key to successful investing
Warren Buffett is not only a brilliant investor; he also has an amazing ability to explain important investing concepts in a simple and straightforward manner. When it comes to identifying top-notch businesses, Buffett had this to say:

The single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business. And if you have to have a prayer session before raising the price by 10%, then you've got a terrible business.

Continue Reading Below

Pricing power is a company's ability to raise prices without losing too much sales volume. This factor has some clear advantages from a financial point of view, as higher prices usually mean a bigger profit margin for the company and higher returns for investors over time.

Perhaps more important, pricing power clearly reflects a company's competitive strengths. Competition tends to keep price hikes at bay. If a company raises prices too much, consumers will typically go for a competitor's cheaper product. Businesses with superior pricing power are those with competitive differentiation, meaning consumers find something unique or superior about that company and its products -- and their willing to pay up for it.

To have pricing power, you need competitive strength. This can come from a higher-quality product, a differentiated brand, technological superiority, other other advantages. In addition to generating higher profitability, competitive advantages protect the business from the competition, and this substantially reduces the risks for investors.

Why Starbucks fits in Buffett's portfolio
When it comes to brand differentiation and pricing power in its industry, Starbucks is second to none. Starbucks is about much more than coffee: The business is all about the customer experience, creating a third place between home and work where consumers can relax and enjoy the company's offerings in a friendly and comfortable environment.

Its brand differentiation, unique cultural footprint, and reputation for quality allow Starbucks to charge premium prices for its products, and customers seem more than happy with the company's proposition.

Starbucks is building a global empire that already features more than 22,000 stores around the world and is growing at full speed. Most companies face slowing growth as they gain size over time, but Starbucks keeps delivering exceptional sales and earnings performance.

Total sales grew 18% to $4.6 billion in the last quarter, while comparable sales grew 7% on the back of a 3% increase in transactions and a 4% increase in the average ticket. Importantly, Starbucks has multiple ways to make consumers spend more on its stores, even if it doesn't raise prices for existing products. The company has introduced new premium products such as Flat White, Reserve, and Cold Brew in the Americas region during the last quarter, and this produced a increase of 5% in the average ticket in the region. Pricing power is not only about rising prices over time; Starbucks is flexing its pricing muscle via product innovation in the high end of the pricing spectrum.

In addition to rising ticket prices, Starbucks has delivered comparable-store sales growth of more than 5% over the last 21 consecutive quarters, which is nothing short of extraordinary for a business of its size. According to CEO Howard Schultz, "No other global retailer approaching our size or store base comes remotely close to posting such consistently strong comp performance."

Customer loyalty is stronger than ever, too. Starbucks ended last quarter with over 10 million My Starbucks Rewards active members, an impressive increase of 27% year over year. The business processes over 8 million mobile payment transactions per week, and it recorded $1.1 billion in North America card loads during the last quarter, an annual increase of 19%.

Profit margin is on the rise thanks to sales leverage and increased operating efficiency. Meanwhile, Starbucks' operating margin was 17% of sales during the last quarter, versus 16.6% of revenue during the same period in the prior year. Rapidly growing sales and rock-solid profitability bode well for Starbucks investors in the years ahead.

Management aims to generate $30 billion in annualrevenue by fiscal 2019, an aggressive growth target from $16 billion in fiscal 2014. While the plan is clearly ambitious, it does not sound unreasonable considering Starbucks' fundamental strengths and financial performance.

Warren Buffett loves companies with competitive differentiation and superior pricing power, and Starbucks excels in those areas. For this reason, the global coffee powerhouse deserves a place in Buffett's portfolio.

The article 1 Retailer That Would Fit in Warren Buffett's Portfolio originally appeared on Fool.com.

Andrs Cardenal owns shares of Apple. The Motley Fool recommends Apple and Starbucks. The Motley Fool owns shares of Apple and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.