There are pockets of the market that can give investors growth opportunities that don’t have to be related to the tech sector or the artificial intelligence (AI) trend. Dutch Bros (NYSE: BROS) is proof of that.
But shares have been a disappointment in recent years. They have lost about 13% of their value since the initial public offering in September 2021. Some people might view this as a good opportunity to make a move.
Should you buy this mid-cap stock while it trades well below $40 per share? Here’s what investors need to know.
Dutch Bros is in growth mode
Dutch Bros is probably a top choice for investors seeking growth potential in the restaurant sector. The company reported a revenue jump of 30% in the second quarter (ended June 30). This was partly driven by same-store sales growth of 4.1%, which is healthy given the uncertainty across the economy.
Another big part of Dutch Bros’ strategy is to expand the physical footprint. After 30 new locations opened in the last three months, there are now 671 stores in the U.S. Executives have explicitly stated that the target is to get to 4,000 locations in the next 10 to 15 years.
When companies are fully focused on expansion, as is the case here, there are typically no profits being reported. Here’s where Dutch Bros bucks the trend. Net income soared roughly 130% from $9.7 million in Q2 2023 to $22.2 million in the latest quarter. Expenses are rising at a slower rate than the top line, a positive trend.
According to Wall Street consensus analyst estimates, the business is projected to increase sales and earnings per share at compound annual rates of 22.3% and 25.3%, respectively, between 2023 and 2026. This is a robust outlook.
Valuation and quality
As of this writing, shares trade 58% below their peak, which was established during the last rising market environment in late 2021. Investor sentiment has cooled down considerably since that record was reached. But the stock still looks extremely expensive at a price-to-earnings ratio of 127.
For some investors, though, this might not matter. The bulls believe that Dutch Bros can one day get to its target of 4,000 stores. To be clear, these are the only people who should buy the stock. That’s because the current valuation likely bakes in that this favorable outcome is more likely than not to occur. And if the business does hit that goal, revenue and earnings will surely be much higher than they are today.
I’m not as confident. In fact, I believe that Dutch Bros still has a lot to prove before it’s worthy of investment consideration.
One reason I feel this way is because I don’t think the business possesses an economic moat. Despite its recent struggles, Starbucks clearly dominates this industry. Over the decades, it has developed durable competitive strengths that stem from its powerful brand recognition, as well as cost advantages.
Dutch Bros doesn’t hold a candle to Starbucks’ long-running relevance. And with the latter having a store base that’s about 25 times the size of the former’s footprint just in the U.S., Dutch Bros has a lot of work to do before it can even be mentioned in the same breath as the market leader.
Investors always fall in love with a good growth story. But the reality is that strong growth doesn’t last forever. In Dutch Bros’ case, there’s downside should the gains slow down, something that wouldn’t surprise me if it happened. The retail coffee industry is one of the most competitive around, with no barriers to entry or switching costs.
Even at a price below $40 per share, investors should stay away from Dutch Bros.
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Neil Patel and his clients have 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.
Should You Buy Dutch Bros Stock While It’s Below $40? was originally published by The Motley Fool
