Grab Starbucks on the dip before coffee futures fall

Key Points

• Starbucks stock is underperforming its peers, and there is no other reason than a robust fundamental relationship in its costs.
• Coffee beans have ripped a new rally lately, squeezing profits at America's favorite brewer. However, it doesn't mean all bad news.
• Whether a new buy or a dip-add, there are ways for you to protect your shares against further swings in the price of coffee.

The stock market has been on a wild ride so far this year, with wild swings and emotional roller coasters. Don't you remember when everyone was scared of a recession once the FED began raising rates? And how about the banking crisis that took down a few institutions?

Now, the S&P 500 closed the month of November on a very bullish note, meaning that most stocks that are not making 52-week highs have some catching up to do, and who better to attract buyers on a recent dip than Starbucks NASDAQ: SBUX?

Regarding retail stocks, only a few are experiencing the price action seen in Starbucks, meaning the problems brewing in this stock must be company-specific rather than one with the entire space. The answer: coffee beans are on the rise, but that doesn't mean you can't hedge.

Bargain hunting 

Keep in mind that the gross margins at the coffee giant are mainly driven by the cost of the product they are brewing every day. According to the Intercontinental Exchange NYSE: ICE, the price of coffee bean futures has gone up from roughly $177.7 to today's $183.1, a bump of 3.0%.

While this may not seem like an alarming rise, some believe there could be more to come, as the crop levels coming out of Vietnam seem to be getting squeezed thinner by the day. This could be bad news for those already owning Starbucks and good news for those looking to buy it.

You see, while it is a no brainer that more expensive raw materials will squeeze margins - and ultimately earnings - at Starbucks, there are ways for you to still potentially buy the stock and cover yourself in case the cost of coffee beans does keep rising.

After all, what if you decide to sit and wait for the stock to find a potential bottom out of fear that coffee beans shoot up, only to wake up one day and see Starbucks meet its analyst price targets of $114.5 a share? That's a whole 20.0% you'd be missing out on, by the way.

So, pretend you already own the stock today, and despite facing a 20% upside, there is the growing worry of earnings being chiseled down by the cost of coffee beans. Here's what you can do to ease the pain.

Gap to close

Consider other stocks in the space, like Chipotle Mexican Grill NYSE: CMG, that enjoy the seeming immunity to the business cycle alongside deep brand name penetration, making them a consumer favorite in their common - though unique - everyday products.

Chipotle stock is trading basically at its 52-week high, which makes it the prime example of what other stocks like it - e.g. Starbucks - should be experiencing today. Starbucks is offering a steep discount on this measure, as its price action shows it trades at only 84.0% of its 52-week high.

There is absolutely no reason, other than rising costs of coffee beans, for Starbucks stock to be such a lagger in this space, especially when you realize that its product is as defensive as it gets, it's a daily ritual for most people!

Knowing what you know now, between analyst bullish sentiment and targets, as well as the technicalities of price action, it is time to figure out how to protect your capital in case it is already exposed to Starbucks stock; otherwise, how to structure a safer investment in it. 

By comparing Starbucks's stock chart against the iPath Series B Bloomberg Coffee Subindex Total Return ETN NYSEARCA: JO, you can see where the relationship is between the price of Starbucks versus this fund, whose performance is directly tied to the performance of coffee bean futures.

Noticing a seemingly negative relationship, meaning that Starbucks tends to rise when the futures fund declines, it would be ideal to place some of your capital in the fund as well.

If Starbucks stock were to drop due to a rise in the cost of coffee (as it is today), your P/L would be protected by a long in the fund simultaneously.

This insurance can calm your nerves if you already own the stock and are afraid of selling it only to see it rally to analyst targets. Now suppose you don't already own it.

In that case, you can rest assured that this is a silver bullet you can fire at any time during the entry or management of your potential new investment.