Krispy Kremed?

In the early 1990s, when I worked in lower Manhattan, I used to stop every day at a cart on 14th Street to buy a cup of coffee and a doughnut, for a grand total of $1. By the end of the 1990s, I was working near Times Square, and as often as not I’d stop on Eighth Avenue for a Starbucks coffee and a Krispy Kreme doughnut; the total would come to $2 and something, and I’d throw the change in the tip jar. In other words, I was paying 200 percent more than I’d paid for my morning snack just a few years before. Why?

Well, for one thing, you couldn’t get Starbucks coffee or Krispy Kreme doughnuts in Manhattan in the early 1990s. I also suspect that Americans’ willingness to pay a premium for “really good” versions of quotidian products like coffee and doughnuts is far greater now than it was then. Starbucks went public in 1992, and at the end of that year had 165 locations. Gourmet coffee probably did not sound like a viable mass phenomenon, yet by the end of 1999 Starbucks had about 2,200 locations. And its share price, though somewhat rocky in 2000, is up something like 1,400 percent from the IPO.

Which brings us to Krispy Kreme. Earlier this year, the Krispy Kreme doughnut chain went public at $21 a share. The IPO was a hit. In fact, it was out of the park, quickly surging into the $50s. In June, both Forbes and Fortune dissed the stock, calling it overvalued at about $59 a share. By early July it was at about $79, and Barron’s chimed in with a negative piece. It’s since sunk to about $69, but that still means it’s trading at more than 100 times trailing earnings. That’s some pretty astonishing resilience in the face of so much powerful skepticism.

Every stock has a “story,” and the Krispy Kreme story is simple. The doughnuts are good–way better than those of Dunkin’ Donuts. And there are only about 150 outlets, whereas Dunkin’ Donuts has around 3,600 in the United States alone, so Krispy Kreme has huge growth potential. Peter Lynch made a fortune for Magellan holders riding the growth of Dunkin’ Donuts when it was an independent company (Dunkin Donuts is now a division of the British firm Allied Domecq). Maybe the long-term Krispy Kreme story will be similar. 

If you’ve ever had Krispy Kremes then you will grasp the appeal of the underlying product. Kreme fans are absurdly loyal to the hot, sticky little sugar bomb that is the chain’s flagship offering. And if gourmet coffee can be a hit, why not doughnuts? (I’ve noted before in a different context that the Krispy Kreme is essentially a luxury doughnut, a contention that met with some skepticism. Basically the counterargument is: They’re fattening, and they’re from the South. But look: They cost more than other doughnuts; they’re distributed through places like Starbucks and Gourmet Garage, not at NASCAR events; and of course the notion that “Southern” cancels out “upscale” isn’t worth addresssing.) It’s easy to imagine a whole crop of Kremes, right? 

That’s exactly what investors have been doing, creating a pack almost the moment that the chain went public. Packs tend to distort things, and that’s certainly happening here. Analysts, for instance, have even attributed some Kreme outlets’ increased sales in part to publicity surrounding the IPO; this sales bump was of course rewarded by traders.

So, what’s ultimately interesting about Krispy Kreme, then, is that right at the moment it’s clearly too easy to imagine the chain’s success. Among Lynch’s great skills was his ability to spot certain trends early, and he happened to have an excellent feel for the middle-American taste of his day. And as Lynch is still forever pointing out, if you want to be a good investor, you need some sort of edge that gets you to such epiphanies before everyone else. (He also, after field-testing KFC or whatever, washed his hands and pored over the numbers, and Krispy Kreme’s share price has obviously risen way faster than its earnings.) The problem with Krispy Kreme isn’t in deciding whether the product is good or the potential growth is real or if the broader trend sounds right (“Hey, I never used to buy these, and now I do!”). The problem is recognizing how many other investors have decided they know those answers. In this case: lots. Perhaps that means KREM shares can keep floating to the top for a while. Or maybe it means that they’re about to get dunked.

Illustration by Robert Neubecker.