Costco Wholesale Corporation (NASDAQ:COST) has long been considered a premium company and stock because of its business model. The idea that individual consumers could buy products at prices close to wholesale was a stroke of brilliance. COST stock has benefited all these years because that strategy was possible to execute based on three central concepts.
The first concept was that in order to make any kind of margin on wholesale items, they needed to be sold in bulk. By reducing the number of packages necessary to sell, and jamming goods into super-large volume units, selling near-wholesale made sense.
The second concept was to create an in-house private label brand, Kirkland, allowing Costco to manufacture goods that could compete with other high volume products. Just like the grocery stores, it sells those products for less than competitors AND does so in volume. Not only that, its private-label products are also damn fine quality.
Pay to Play
But the ultimate stroke of genius is what Amazon.com, Inc. (NASDAQ:AMZN) took years to figure out — charge a membership fee. To get those low prices and Kirkland products, consumers have to pony up a modest membership fee. It isn’t that much, yet when multiplied by millions of members, Costco makes a fortune and COST stock has lots of recurring and growing revenue.
Think about it. Every time Costco opens a store, it will bring in consumers. Every single one of them will pay that membership fee and probably do so an annual basis. Most businesses rely on whatever revenue they can generate from sales. These guys have an annuity.
Costco also carries brand loyalty. For starters, once someone renews that membership, there’s this nagging thing called “sunk cost”. People will be more likely to continue to shop at Costco, and help the COST stock price, if they’ve already made an investment in the membership.
With Costco earnings due on Thursday, the first number of focus on will be same store comparable sales. That’s the single most important number for any retail operation. Comps are pegged to come in anywhere between 4.5% and 5.7%. Anywhere in that range would be stellar, but it’s worth nothing that 5% comps is tremendous in any business.
EPS is pegged at about $2 per share, with FY18 totals at $6.40 per share. With last year’s quarterly number at $1.77, that’s a 13% YOY increase, on an expected 7% revenue increase. That’s pretty strong considering how large Costco is and that it’s still growing.
Gross profit is slated to grow from $4.91 billion to $5.52 billion, an increase of $631 million or 12.5%. Again, this is really impressive. You’d think Costco stock would have settled into Peter Lynch stalwart territory by now, but that is not the case. Operating income looks to increase $169 million, or 14.2%, to $1.36 billion.
The Bottomline on COST Stock
So what does an investor do? With COST stock trading at 23x earnings on 13% earnings growth, it is too pricey for me. Before I’ll even consider paying a PEG ratio of 1.70, that stock must be growing EPS at 15% at least for several years running. I’m willing to give Costco a premium for having a world-class brand name, and while it’s financials are solid, I think the shares are overpriced.
We are also in a market where stocks in general are 25-30% overvalued.
So I would say not to buy Costco here. If you own it, I would hold onto it because the long-term story is solid.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
