Costco Stock Has Great Fundamentals But An Expensive Price Tag

  • Costco's fundamentals are as good as any company.
  • Unfortunately, that stability and strength comes at a premium price.
  • With a high valuation, slowing growth, and modest dividend payouts, Costco may not appeal to a wide variety of investors.

Great business model, solid growth, and low volatility best sum up Costco (NASDAQ:COST). However, even though the base of Costco’s business is strong, their stock price may be trading at an inflated price tag. Long-term investors see a lot of value in Costco stock and have not been disappointed with the results. The chart below shows its performance in comparison to competitors Walmart (NYSE:WMT) and Target (NYSE:TGT) over the past 5 years.

Source: Costco stock price chart by amigobulls.com

Costco deserves a lot of credit for its growth rate.  It has been able to produce consistent positive growth year-over-year with the exception of 2009.  For the fiscal year 2015, revenue was up 3% to $116 billion.  As time progressed and Costco became bigger, it was only natural for their growth to slow down to the low single digits.  But if there is a sense that the company’s growth is going to level off, then why is it trading at a PE of 29.5, which is significantly higher than the discount stores industry average of 17.2?  This is most likely because Costco’s growth still stacks up nicely against its competition.  If we look at Walmart and Target, they both significantly under-perform in topline growth in comparison to Costco.  Walmart had negative revenue growth last year while Target has been crawling at a 0.2% 3-year average revenue growth rate.  Even with their huge size, Costco still exceeds the industry’s 3-year average revenue growth by more than double.

Although Costco’s growth and resilience throughout different markets and economic conditions has been impressive, it doesn’t impress investors as much with its bottom line. The company has an extremely tight operating margin of 3.1%. However, the saving grace is that Costco is less leveraged than most of its competitors, which allows it to net at about 2%, compared to the industry average of 2.6%. Target carries much more debt than Costco but still has a net margin of about 4.6%, while Walmart has more than 4 times the amount of revenue as Costco and still nets at 3.1%. And if we look at free cash flow, Costco produced only $1.3 billion for the trailing 12 months, which means its trading at 51.5 times FCF which is very rich. Target trades at approximately 11.2 and Walmart at 13.7 times that metric. When you look at numbers like these it is no wonder that Target and Walmart have a dividend yield 2-3 times higher than that of Costco stock.

If you’re looking for a dividend investment, then you might not see Costco as an attractive investment, as its retail competitors offer a better yield. However, it is important to note that Costco still produces value, but your return on investment will be tied more significantly to its stock performance than its dividends. If you look at the trailing twelve months, Walmart has a payout ratio of 42%, Target 40%, and Costco only 30%. So Costco is being more conservative in its dividend payouts, which is why income investors may seek out its competitors as better alternatives for their portfolios.

Conclusion

Costco has great fundamentals and will probably continue on a stronger growth path than its competitors, but that comes at a premium price. With lower dividend payouts than its competitors it is unlikely to draw the attention of income investors, and with growth slowing down to low single digits it is not likely to motivate growth investors either. And considering its high valuation multiples, many value investors will not be intrigued as well. However, the very strong fundamentals of the company have not been ignored by the majority of shareholders, which is why the stock is currently trading at a premium. Costco isn't necessarily a bad stock to have in one's portfolio, but you will be paying a higher price for its growth and solid business model compared to its competitors.

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  • I do not have any business relationship with the companies mentioned in this post.
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