Amazon.com, Inc. (NASDAQ:AMZN) is killing the retail sector, right? Think again, as the SPDR S&P Retail (ETF) (NYSEARCA:XRT) is hitting new annual highs, being led by long-time stalwarts like Home Depot Inc (NYSE:HD) and Costco Wholesale Corporation (NASDAQ:COST). But after hitting new 52-week highs on Friday, is it too late to buy COST stock?
Up “only” 11.4% so far in 2018, COST stock doesn’t seem like it’s too rich to buy from that perspective. However, Costco is rarely a cheap name from a valuation perspective, despite its growth.
My case is pretty simple though: COST stock is a buy, but on a pullback.
Why We Like Costco
I like Costco for several reasons, but one of the main reasons is because it can stand up to Amazon. It creates an unparalleled shopping experience, luring customers in with attractive deals, food samplings and low gas prices. Try getting into a Costco in or near Los Angeles and you’ll see just how popular this store is.
Charging between $60 and $120 for its membership choices, Costco generates a “Prime-like” revenue from its customers. This gives the company more wiggle room as it already has billions in cash flow and revenue before even selling a single product. As the company builds out its e-commerce efforts, Costco is making for a “stickier” ecosystem for its shoppers.
Valuing COST Stock
As Costco continues to improve an already great product and experience, shares continue to run higher. That’s great for long-term holders and not-so-great for those looking to get long.
So what about right now?
COST stock is getting a bit extended — something we’ll take a closer look at in a minute — and just hit new all-time highs at the end of last week. Further, it’s not a cheap stock, even with its superior comp-store sales growth profile.
Costco is forecast to grow revenue 8.6% this year and 7% next year. That goes along with earnings growth of 21.5% this year and about 9% next year. Investors can thank the new tax code for 2018’s big jump in earnings, although many seemed disgruntled that management is passing those gains onto its employees, as shares fell after an otherwise great earnings report.
Do these shareholders not realize that the great customer experience is because of the employees and the low turnover rate keeps costs low?
COST stock now trades at almost 30 times this year’s earnings expectations, a lofty figure indeed. But where else can you find a retailer growing like Costco, with this strong of a brand and a seemingly Amazon-proof business model? I shouldn’t say completely Amazon-proof, but it’s not going through devastation like Sears Holding Corp (NASDAQ:SHLD) or revamping itself like Walmart Inc (NYSE:WMT).
In May, net sales surged more than 14%, while comp-store sales grew 11.7%. Excluding gas sales, comp-store sales still jumped 8%. It’s hard — impossible, maybe? — to find that kind of growth from this big of a retailer. That’s why despite a lofty valuation I want to buy COST stock. But I want a pullback first.
Trading COST Stock
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It’s funny how so many investors wanted nothing to do with Costco as it was struggling in the $150s last summer. Yet, after jumping through $200 though, many investors seem content to bid it higher.
On the chart above, you can see a blue line at $200 and a trend-line drawn in black. Ideally, investors could a buy a pullback into trend-line support, but will it decline that far? It would require about a 6% pullback from current levels, which doesn’t seem to be asking for too much.
But given that shares are “only” up 11% on the year — despite robust results — says to me that maybe COST stock doesn’t fall that far. If it does and you want to own Costco, I wouldn’t recommend hesitating with your buy order between $190 and $200. There’s plenty of support to keep Costco shares afloat near that range.
The market has been hot and if it cools, COST stock could come under pressure. Further, perhaps the BJ’s Wholesale IPO will pressure Costco shares. If so, I think it’s a buying opportunity.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
