Have Analysts Become Too Bearish on Costco Stock?

COST stock - Have Analysts Become Too Bearish on Costco Stock?

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Since mid-April, Costco Wholesale Corporation (NASDAQ:COST) stock has had quite a run. COST stock was somewhat choppy in 2017, but 2018 has been a different story. Costco stock has gained 25% so far this year, and nearly all of the gains have come over the last five months.

The run has come to an end over the past couple of sessions, partly due to some caution by Wall Street. A monster August sales report sent COST stock to record highs. But since then, analysts have sounded warning bells.

Wells Fargo downgraded the stock to Market Perform, mostly on valuation concerns. The head of technical analysis at Piper Jaffray told CNBC that the parabolic chart of Costco stock was likely to end “badly”. Barclays added its own valuation concerns on Monday. And while those firms made headlines recently, they don’t appear to be alone. The consensus price target among analysts for COST stock is $232, modestly below its current level of $234.

Although there are reasons to like Costco stock, the concerns seem valid to me. Costco stock is as expensive as it’s ever been. Meanwhile, external factors have all been in the company’s favor. Betting against COST stock seems silly from a long-term standpoint, and this remains one of the best companies in the market. But from a valuation standpoint, there’s real reason for concern.

The Tailwinds Behind Costco Stock

There’s seemingly no fundamental reason to even consider abandoning COST stock at this point. The company’s performance in its fiscal 2018, (which ended on Sept. 2) was absolutely torrid. COST will report its fourth quarter earnings early next month, but its sales figures have been extremely impressive. Its revenue surged 12.2% year-over-year last month, completing a Q4 in which U.S. same-store sales rose a sizzling 10.8%. For the year, U.S. comp sales rose 9.4%, with the international operations actually performing slightly better.

In that context, the performance of COST stock so far this year makes some sense. But looking to FY19, there are some reasons to be concerned. Pretty much everything has gone right for COST so far this year, as Wells Fargo pointed out. Walmart (NYSE:WMT) unit Sam’s Club closed 63 stores. US tax reform put money in shoppers’ pockets. Costco’s launch of a new credit card in partnership with Visa (NYSE:V) has provided benefits after early struggles.

Costco heads into FY19 with tough comparisons and will lap both tax reform and the Sam’s Club closures in early January. As a result, growth next year will slow at the same time that COST stock trades at near-peak valuations.

Costco Stock Looks Expensive

According to Barclays, COST stock trades at 16 times its forward EBITDA; the figure was closer to 17 times when Wells Fargo downgraded Costco stock. Either multiple represents the highest valuation for Costco stock in over a decade. So, too, does a forward price-earnings multiple that still sits above 30.

Admittedly, in this market, 30 times isn’t a huge multiple. Quality companies across the board are getting similar valuations and continuing to march higher. But investors may also be forgetting about some of the concerns that kept a lid on Costco stock barely a year ago.

After all, last summer COST stock plunged after Kroger (NYSE:KR) cut its guidance and Amazon.com (NASDAQ:AMZN) acquired Whole Foods. And as COST has soared, WMT stock has rebounded, as have shares of Target (NYSE:TGT).

Certainly, the performance of large grocers (even with KR’s plunge last week) suggests that last year’s worries were overdone. But the concerns about a space with razor-thin operating margins aren’t completely gone. COST no doubt looks like the best company in its sector. But it’s still a sector that investors have real concerns about. Consequently.  they probably won’t keep paying something like 20 times EBITDA or 35 times+ net income for a name in that sector for long.

Should Investors Stick With COST Stock?

On the other hand, it’s not as if Costco’s growth is ending. It’s clearly taking market share, not just from Sam’s Club, but also from rivals that don’t charge membership fees.

And it’s not as if Costco stock is ever cheap. The stock usually has a price-earnings ratio in the mid-20s, and its performance has been more than enough to not only support those multiples, but to easily outpace the market as a whole. If an investor is going to pay more for quality, COST stock seems like the right choice.

I’m sympathetic to that argument, and I’m hardly recommending shorting COST stock. Over the long-term, COST can probably advance further. But even after a 4%+ pullback, the valuation concerns are real. Costco is as expensive as it has been in over a decade. The company is also performing better than it has at any time during that period. It’s unlikely that both of those trends will continue forever, and when even one of them stops, COST stock could tumble over the short-term.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media, https://investorplace.com/2018/09/street-right-calling-peak-costco-stock/.

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