Costco Wholesale stock is the Palantir Technologies for the retail industry, with a steep valuation. It also boasts a fervent investor base.
Warehouse giant continues to provide value to its 77,000,000 members worldwide, with unbeatable offers like $4.99 rotisserie hens and a hot dog and soda combination of $1.50 – unchanged for 40 years.
Since 1985, the stock of the company has increased by 600-fold.
Investors are left with many questions about the current value of the stock.
Costco’s shares are up 45% by 2024. They reached $962, and trade at 53 times earnings in the future. Tesla is the only company that can match this level amongst S&P 500 top 20 companies.
Analysts warn in a Barron’s Report that such lofty multiples might not align with Costco’s expected growth of 10% per year in earnings per share in the coming years.
Bull case for COST model and its merits
Costco’s model is still a favorite among analysts and customers alike, despite valuation concerns.
Costco’s revenue will rise by 7% this fiscal year after a similar increase in 2024.
Over the past two decades, same-store sales have increased between 5% and 6 % annually.
Costco’s nearly 600 stores in the US are expanding by 25-30 per year, a reflection of the strong demand for their value-oriented approach.
Costco’s expansion abroad is praised by JPMorgan analyst Christopher Horvers, who notes its success in each country where it has been established.
The brand is popular worldwide, as evidenced by the long lines that often form at new locations.
Source: Barron’s
Simeon Gutman, a Morgan Stanley analyst, shares this optimism and predicts accelerated profit growth.
He maintains a Overweight rating, with a price target of $1,150, which implies a nearly 20% increase from current levels.
Costco’s success is largely due to its membership fees, which account for around half of the company’s operating profits.
The membership fee will increase by $5 to $65 per year in September 2024, the first hike in seven-years.
Nearly half of the members choose to purchase the Executive Membership for $130.
Bulls claim that these fees, which have a renewal rate of over 90%, provide a constant income stream and give Costco an Netflix appeal. They also justify the large P/E multiples the company enjoys.
Analysts warn against Costco’s high price.
Brian Yarbrough is a retail analyst with Edward Jones. He points out that Costco’s value was 40 times its forward earnings at the start of 2024, and 30 times before the Covid-19 pandemic.
This could indicate that the stock’s momentum will be lost as earnings are aligned with its current price. Or, it could fall by up to 20% if there is a market decline or an unexpected profit or revenue shortfall.
He says
Costco is a high-quality retailer, but the stock valuation is difficult to justify.
If the stock price drops to $725 if it returns to a modest valuation of 40-times projected earnings for 2025, its price may drop by more than 20%.
Costco’s stock compare with other tech giants Source: Barron’s
Costco is overpriced even among its competitors.
Growth stocks such as Apple, Microsoft and Nvidia are trading at around 30 times earnings forward, while Walmart, Amazon, and other companies hover around 35 times.
Costco’s price-to-earnings-to-growth (PEG) ratio of five starkly contrasts with the two-to-three range seen in most growth stocks.
Analysts at Trivariate Research share a cautious outlook.
Their data shows that companies that breach a P/E ratio of 50 for the first time, often fall below 40 in a year and underperform the market over the next three years. They say:
Costco’s business model is certainly unique, but it’s valuation is astronomical for a company whose top line growth hasn’t changed much in the past.
Yarbrough shares this view, stating that Costco’s high-quality reputation does not justify its high stock price.
He says that it will be difficult for the stock to perform better over the next three or four years.
Growing pains: Limited US expansion potential
Costco’s growth trajectory is facing challenges, even though it continues to grow.
Bill Smead of the Smead Value Fund highlights that Costco’s huge $250 billion annual sales make it mathematically impossible to sustain past growth.
The company is still successful in opening new stores, both in established markets like Pleasanton, California and in new territories such as Scarborough, Maine.
The runway for US expansion is shrinking.
CEO Ron Vachris is optimistic, citing untapped domestic and foreign markets. But analysts like Smead have compared Costco’s valuation to that of the “Nifty 50” stocks from the 1970s. These stocks underperformed significantly over the next decade.
What are the risks of a stock pullback? Should you sell it?
Costco is not an exception. History has shown that steep valuations often lead to corrections.
Trivariate Research warns that companies with a high P/E ratio often underperform in the long run.
Costco’s fundamentals are not in immediate danger, but a market selloff or unexpected earnings missed could cause a sharp drop.
The argument that membership fees should be valued separately from retail profits is still controversial.
Yarbrough argues that Costco’s integrated strategy makes such distinctions impossible.
Costco’s strengths, from its membership-driven business model to its unwavering commitment towards value, are undeniable.
Its loyal clientele, low rates of shoplifting, and experienced management team are all testaments to its excellence in operations.
The stock’s valuation is stretched, particularly in light of its modest growth forecasts.
Costco’s current price is not the issue for long-term investors. The question is whether future returns are justified by its current price.
Investors may want to reassess positions now that the risk of a pullback is looming.
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