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Costco Stock: Growing Financials, Runaway Valuation
Stock Analysis & Ideas

Costco Stock: Growing Financials, Runaway Valuation

Costco (NASDAQ: COST) primarily specializes in the management of membership warehouses.

The company currently operates 823 warehouses, 571 of which are located in the United States and Puerto Rico, while Costco also operates e-commerce sites in the U.S., Canada, the United Kingdom, Taiwan, Japan, Australia, Mexico, and Korea.

What distinguishes Costco from the rest of traditional retailers is its membership plan, which results in a consistent stream of predictable cash flows for the company.

Hence, Costco is able to offer products at a generous discount, which in turn maximizes customer retention, resulting in outstanding economies of scale.

Costco’s growing financials over the years have bred incredible shareholder returns. That said, investors must be wary as shares have consistently traded at a premium.

On the one hand, I respect the company’s remarkable qualities. On the other, Costco’s investment case may be offering limited upside in the short term at its current valuation levels. For this reason, I am neutral on the stock.

Solid Growth

Costco’s Q1 2022 results were very strong, with revenues growing 16.7% year-over-year to $49.42 billion, compared to $42.35 billion last year.

Comparable sales in the U.S., Canada, and internationally were 13.9%, 17.2%, and 13.4% higher, respectively, following strong consumer spending. The company also grew its e-commerce sales by 14.3%. Out of total sales, $946 million were attributed to membership fee income.

Consequently, net income also grew to $1.32 billion (EPS of $2.98), compared to $1.16 billion (EPS of $2.62) in Q1 2021.

Despite the business model’s razor-thin margins, the company managed to retain its gross margins in the double digits. They were 12.73%, compared to last quarter’s 12.67%. Net income margins came in at 2.63%.

Still Expensive

Costco’s growth has remained robust over the past few years, with the company’s overall expansion performing greatly, especially in Asia.

As the company keeps accomplishing operational efficiencies and higher margins, profitability should keep expanding going forward. For this reason, investors have fixed, as always, elevated expectations from the company.

Analysts currently expect FY 2022 EPS of around $12.69, which implies a forward P/E of 41.1. This is a rich premium for the industry.

Target and Walmart, for context, trade with forward P/Es of 18.2 and 21.2, respectively.

On the one hand, Costco’s developments over the years have been exceptional, and profitability should ultimately grow into the current valuation. However, I see little to no upside in terms of a valuation expansion further from the stock’s already expanded multiple.

In fact, any headwinds could easily lead to a valuation multiple contraction. Combined with the relatively tiny dividend yield, I believe that investors‘ margin of safety is also quite thin.

Wall Street’s Take

Turning to Wall Street, Costco has a Strong Buy consensus rating, based on 18 Buys and four Holds assigned in the past three months. At $577.24, the average COST price target implies 10.6% upside potential.

Conclusion

Following an excellent FY 2021, Costco entered FY 2022 featuring robust growth metrics and satisfactory margins. Simultaneously, however, the stock has become increasingly more expensive.

Hence, investors should be cautious regarding allocating capital at the stock’s current levels.

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