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Costco Stock: Fairly Valued at Current Levels

Costco Wholesale (COST) is a membership-based seller of groceries, electronics, home goods, and many other products in the U.S. and internationally.

The stock is up over 43% over the past year, but has struggled thus far in 2022. Costco may be an enticing investment with investors seeking defensive positions in the market; however, investors should be cautious considering the current price-to-earnings ratio.

The author is neutral on Costco stock.

Macroeconomic Picture

Several macroeconomic factors will affect Costco, some positive and others negative. The foremost issue causing headaches on Wall Street is inflation. In January, the consumer price index (CPI) reached an annual rate of 7.5%. This is the highest figure in 40 years.

The inflation rate affects the market in multiple ways. First, it will almost certainly cause the Federal Reserve to raise interest several times in 2022.

Raising interest rates reduces inflation by making it more expensive to borrow money, thus slowing the economy. Rising rates also change the valuations of stocks, and have a particularly negative effect on growth names.

Costco Could Benefit

These conditions can benefit Costco in two ways. First, when prices rise, consumers become more price-conscious. Costco could be a winner here as it offers steep discounts on many products for its members. Rising prices could spur more people to become members.

The second way the stock could benefit is the desire for investors to take defensive positions in the stock market. In times of uncertainty, investors will often seek safer investment options.

One of the popular options is the Consumer Staple sector. Consumer staples are products consumers will need to purchase regardless of economic conditions, such as food and home goods.

On the other hand, COVID-19 and the Omicron variant have caused supply-chain bottlenecks globally. This has increased costs for many retailers and wholesalers to procure goods.

Thus far, Costco has effectively passed these costs on to consumers as the gross profit margin remained steady at 13% in fiscal 2021.

Excellent 2021 Results

Costco posted terrific results for fiscal 2021. Total sales rose over 17% over fiscal 2020 to $196 billion. Gross profit rose 1`6% as well, reaching $25 billion in fiscal 2021.

Diluted earnings-per-share (EPS) rose to $11.30. The rapid growth may indicate that price-conscious consumers flock to value options like Costco.

Costco also pays a consistent and growing dividend, albeit with a small yield. The current dividend of $3.16 annually per share provides a yield of 0.62%. The yield is small, but the dividend is safe and rising.

One concern for would-be investors in Costco is the current price-to-earnings (P/E) ratio. The stock currently trades at a P/E over 44, which is relatively high for a value stock, and higher than the stock has generally traded for historically.

Wall Street’s Take

On Wall Street, analysts are bullish on Costco’s stock. Analysts have a Strong Buy consensus rating based on 18 Buys, four Holds, and no Sell ratings. The lack of sell ratings given the current P/E ratio shows that analysts are confident in the company’s ability to grow and increase profitability.

The average Costco price target of $578.48 implies 12.3% upside potential.

Summary

Costco could be a beneficiary of the current market conditions. Consumers are feeling the pinch of inflation and will likely flock to low-cost options for staple items.

Likewise, investors will begin looking to the consumer staple sector for solid value stocks as growth stocks lose favor. Costco has a safe and rising dividend, and the stock has been a consistent performer in recent years.

The current P/E ratio could prove to be the major stumbling block to market-beating gains.

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