Costco Stock at $945: Here’s Why Investors Should Pause
Costco Wholesale (COST +1.16%) has been an undeniable winner for investors for a long time. The members-only warehouse retailer has built an empire on $1.50 hot dog meals and generated over 580% total returns over the past decade alone.
But it may be time to pause with shares trading at $945. As much as consumers love shopping at Costco, and as well-run as the company might be, even a perfect business can be a lousy stock if investors overpay for it.
A rich valuation that reflects Costco’s many positive qualities
The issue isn’t Costco as a company. It’s a world-class business that leans on its overwhelming size and scale to sell bulk merchandise at low prices, making most of its profits on the membership fees consumers pay to shop at its club stores.
Image source: Getty Images
The issue lies in the stock’s valuation. It’s not necessarily bad to pay a higher price for excellent stocks, as long as it’s within reason. Right now, Costco is trading at approximately 46 times this year’s earnings estimates. That’s a significant premium to the broader market.
Meanwhile, Wall Street analysts estimate that Costco will grow earnings at an average rate of just over 10% annually over the next three to five years. That’s just not enough growth to make investors feel very comfortable about that valuation. It works out to a PEG ratio of about 4.6, which means you’re paying a hefty price for the growth you’re likely going to get.
Building wealth becomes harder at these levels
I’ve always compared stock valuations to gravity. The higher you go, the harder gravity pulls you back.
Overpaying for a stock is similar in that it’s more difficult to see the returns you’re looking for. There’s a greater risk of the stock crashing if the business suddenly slows down. Or the stock can simply trade sideways while the business catches up to the stock price.
Today’s Change
(1.16%) $10.81
Current Price
$945.47
Key Data Points
Market Cap
Day’s Range
$937.11 – $953.73
52wk Range
$844.06 – $1096.50
Volume
1.4M
Avg Vol
2.3M
Gross Margin
12.88%
Dividend Yield
0.59%
Costco has traded at an average of about 32 times earnings over its lifetime. In other words, the stock is about 43% more expensive than it typically is. Even if earnings grow as expected, a reversion to that average would likely be painful for investors. Of course, the stock could also fall below its average.
Time is the best remedy here. Eventually, the business could grow, driving the stock price higher and continuing to build wealth. The point, though, is that it’s much harder when you overpay. You’re stacking the deck against yourself.
That doesn’t mean you have to sell Costco stock if you already own it. But if you’re a prospective buyer, it’s probably best to wait until the stock is trading at least a bit closer to those historical norms before putting your hard-earned capital at stake.
Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale. The Motley Fool has a disclosure policy.
