Costco: Strong Performance, Premium Valuation

When it comes to consumer defensive stocks, there are handful that really stand out. Interestingly, they stand out for different reasons, and each have their own merits as a portfolio staple.

Today, I’d like to focus on Costco (NASDAQ: COST), which has been one of the best retail stocks to own for the past decade.

While I like the company, I am cautiously bullish on Costco over the short term given current valuations. Long term, the company is a rock-solid foundational stock.

Company Overview

Costco is an industry leading warehouse club which has 815 stores worldwide as of the end of Fiscal Year 2021. The company is primarily a North American stock as it derives most of its revenue in the United States (72%) and Canada (14%).

The company’s business model is quite simple. It sells memberships that allow customers to shop in its warehouses, which feature low prices on a limited product assortment. Approximately 20% of paid members carry business memberships, and over 75% of its locations offer fuel.

Here is the company’s sales breakdown by segment as of end of FY 2021:

• Food and Sundries (40%)
• Non-Food Merchandise (29%)
• Warehouse Ancillary and Other Businesses (such as fuel and pharmacy) (17%)
• Fresh Food (14%)

Impressive Growth

Costco has been growing at a rapid pace and has averaged 10.54% annual revenue growth over the past five years. Likewise, earnings per share and free cash flow have grown by 16% and 52% annually over the same period.

These growth rates trounce those of competitors such as Walmart and Target which have only averaged single-digit growth.

It is why the company has also far outperformed its peers. Over the past decade, Costco’s stock has returned 607.56% and a $10,00 investment in the stock would be worth $70,756.35 today.

Looking forward, Costco is expected to maintain double-digit growth rates. Analysts are expecting revenue and earnings to grow in the high teens in Fiscal Year 2022. They are also targeting long-term EPS growth of ~10% annually.

Premium Valuation

The only drawback to the company’s strong performance is that it isn’t cheap. Investors are likely paying a premium for Costco’s growth as valuations are far above the industry. As of writing, Costco is trading at 46.1 times forward earnings, 1.04 times forward sales and over 50 times free cash flow.

These numbers are slightly above the company’s five-year historical averages. This is notable because forward growth rates aren’t as robust as they once were. So in effect, investors are paying a higher premium today for the company’s expected growth.

This isn’t to say that Costco won’t continue to return exceptional results and that investors won’t be rewarded. What does it mean? Investors shouldn’t expect the company to match the stock’s historical 21% compound annual growth rate it achieved over the past decade.

Overall, Costco remains one of the fastest growing among all those in the Discount Stores industry. While investors are paying a premium today and may want to consider waiting for a pullback, Costco makes for an excellent long-term investment and one of the best blue chip stocks to anchor one’s portfolio.

Wall Street’s Take

From Wall Street analysts, the Costco earns a Strong Buy analyst consensus based on 18 Buy ratings, four Hold ratings, and no Sell ratings.

The average Costco price target of $577.24 puts the upside potential at 11.2%.

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