The market is on fire right now, and it's currently in record territory. Some stocks have done remarkably well as bullish sentiment has taken over.
Just look at Dutch Bros (BROS -4.41%). As of Dec. 5, its shares have soared 66% since the start of November. Does this momentum make the supercharged stock, which is still 28% below its peak from November 2021, a smart buy today?
Strong financial results
It appears as though Dutch Bros' stock surge can partly be attributed to the company's latest financial update. During the three-month period that ended Sept. 30, revenue soared 28% year over year, driven by 2.7% same-store sales (SSS) growth. That's a strong showing when you consider that the heavyweight in the retail coffee industry, Starbucks, reported a disappointing 6% SSS drop domestically in its latest fiscal quarter.
Dutch Bros is opening stores quickly, adding 38 net new locations to the footprint in the last three months. The current store count of 950 (645 of these are company-owned) is 157% higher than it was at the end of 2019.
Management is also focused on key initiatives. Dutch Bros started selling food at six locations, which could lead to additional revenue. And with mobile ordering almost fully rolled out, Dutch Bros is increasing accessibility and convenience for customers. These moves look like low-hanging fruit that should slowly make Dutch Bros resemble Starbucks more over time.
The market was pleased with the most recent numbers released by the business, as shares popped 28% the day after the announcement was made on Nov. 6.
Bullish on Dutch Bros
It's hard to ignore the excitement this company is generating from the investment community. I believe there are two primary reasons the market is bullish on Dutch Bros.
The first reason is growth. Dutch Bros' total store count is tiny when you realize that there are 875,000 restaurant locations in total in the U.S. Management sees a huge opportunity to expand, though, as it's set a target to have 4,000 stores open in the next 10 to 15 years, more than fourfold the current footprint. At this scale, the company's revenue base will surely be much higher than it is today.
At the end of the day, what really matters is if a business can generate increasing earnings over time. To be clear, Dutch Bros generated positive net income of $21.7 million in Q3, up 62% year over year. As the business starts to hopefully benefit from cost advantages as it expands, it's reasonable to expect the bottom line to grow faster than the top line. This is probably another reason the market is bullish.
Reasons to be cautious
After the stock's latest jump, it trades at a price-to-sales (P/S) ratio of 4.3. That's more than double the valuation from the start of this year. And it represents a 38% premium to the P/S ratio of industry leader Starbucks.
That valuation, which I believe is expensive, might still be compelling for certain investors who believe Dutch Bros will continue posting stellar growth. I'm not as confident that this rosy outlook is a certainty.
I question whether Dutch Bros has developed sustainable competitive advantages, otherwise known as an economic moat. The company undoubtedly benefits from heightened consumer interest. But after visiting a store in the Phoenix area and having to wait 45 minutes in the drive-thru, there was nothing special about the coffee that warranted that kind of long wait. I believe the excitement customers have will start to fade.
Dutch Bros is much smaller than Starbucks, so it hasn't developed the same global brand recognition or cost advantages, particularly when leveraging marketing and tech expenses and when procuring inputs. Maybe it will get there one day, but that's hard to know in advance.
Hats off to you if you rode Dutch Bros stock to huge gains in the past few weeks. But I don't believe the shares are a smart buy right now.
