There’s nothing inherently wrong with Costco (Nasdaq:COST). It’s just a lot to expect a stock that’s already twice as expensive as its peers — namely Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) — to continue to rise. That’s why Costco shares likely won’t. In fact, if the chart’s history is any guide, Costco shares are at the point where a pullback can be expected.
Fans of retailers need not worry though. Costco’s price dip may ultimately benefit one or both of those competitors.
Too Much Is Too Much
It’s nothing we haven’t seen before, but something we see all too often. A company’s earnings are respectably-but-modestly on the rise, but the stock’s price is soaring as if that company is the only one left in the world. Costco’s in that boat now. Over the past four quarters, trailing twelve-month EPS has moved from $2.80 to $3.19 — a solid 14% improvement in the discount retailer’s annual earnings. Yet, the stock has jumped from $56 to $80 during the same timeframe — a ridiculous (and unsustainable) 42% move. The end result is a frothy trailing P/E ratio of 25.1.
For comparison, both Wal-Mart and Target shares are trading at 12.4 times their trailing earnings — half of what Costco is trying to justify. And it probably won’t be able to do so much longer as the weight of that gain and the excessive valuation bear down.
We saw COST reach comparable overbought levels in late 2009, as measured by the distance between it and its 200-day moving average line (red) at the time. The stock could only reach about 20% above the 200-day line before being reeled in by a move that ultimately pulled it all the way under that long-term moving average.
The peak separation between Costco shares this time around? About 19%, from late May. That’s when trouble started (again), and perhaps not surprisingly, the P/E ratio at this year’s peak was the same 25 as the 2009 peak.
Point being, there are multiple prompts for a pullback here above and beyond the fact the stock’s been fading over the past couple of weeks.
Birds of a Feather Don’t Always Flock Together
It’s somewhat unusual, but this is a case where the individual stocks in the industry aren’t mirroring one another. Costco is the outlier. In fact, Wal-Mart has somehow avoided any kind of meaningful rally since the marketwide rebound began.
That could also be changing soon though. The sideways range between $47 and $64 that had kept this chart contained since the beginning of the 2000s has been getting even narrower since 2008 as a falling resistance line and a rising support line (both blue) have started to squeeze WMT shares. Those lines are almost to a point though, and the stock will have to make a move outside of the wedge sooner rather than later.
Given the continued earnings growth and the fact that shares are about as cheap as they’ve been in years, the odds favor a bullish move out of this wedge shape.
Target shares are the least overbought of the three, so much so that one could still argue they’re oversold from a steep decline made over the course of the first half of this year. The stock rebounded sharply three weeks ago, though perhaps too sharply — the bullish effort has come to a grinding halt in the meantime. Still, TGT is holding its ground around $51 while the bulls catch their breath from the move higher, from a low of $45.65.
The big hurdle and buy-signal for Target at this point is its 200-day moving average line (red) at $52.65. The value is certainly in place.
Bottom Line
While many investors will make a point of buying a stock after a dip or buying a stock with a discounted valuation, very few of these same investors apply the criteria in reverse when things are at the other end of the spectrum. Big mistake.
Right now, Costco Wholesale is poised to pay the piper, and could fall as much as 15% if its history is any guide. Wal-Mart and Target are the better discount retailer bets here, as they both have more upside left in front of them than behind them.
(Nasdaq:COST)
