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Why Costco Stock Will Stay Strong

Costco stock keeps winning despite the market's struggles, and that trend should persist

By Luke Lango, InvestorPlace Contributor

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Margin Pressures Could Hold Costco Stock Back, but Not for Long

Source: Mike Mozart via Flickr (Modified)

Financial markets have been bruised and battered over the past two months, with the S&P 500 shedding nearly 10% during that stretch and the Nasdaq dropping over 12%. But one stock that has weathered the storm with impressive resilience is Costco (NASDAQ:COST). While the broader averages are in correction territory, Costco stock is less than 5% from its all-time highs.

Why? Because while broader markets are worried about higher interest rates and higher tariffs dragging down global economic growth, Costco is reporting its best results in a decade, and those numbers are only getting better. On Thursday, Costco reported that its U.S. comparable sales ex-fuel rose more than 10% in November, more than double the consensus estimate and meaningfully higher than October’s 7% increase.

As a result, while the markets tumbled on Thursday, COST stock popped.

That trend should persist. Costco stock will keep bucking the market downtrend because it’s a highly attractive combination of growth and defense. Due to the strength of the U.S. consumer, Costco is growing rapidly. At the same time, the low cost of the company’s products should largely insulate COST from an economic slowdown. If the economy worsens, consumers won’t stop shopping at low-cost COST. If anything, they will start shopping there more.

Consequently, Costco stock is an attractive combination of growth and defense. That combination will enable Costco stock to buck the broader market downtrend for the foreseeable future.

Costco Stock Will Remain on Fire for a Long Time

Costco just reported November sales numbers, and they were nothing short of jaw-dropping.

Comparable sales in the U.S. ex-fuel rose 10.2%. Analysts were looking for just 4.9% growth. Also, that 10.2% mark is the best number COST has reported in a long, long time. Since 2010, Costco’s U.S. comparable sales growth ex-fuel has averaged around 5%-6%, so a 10%-plus mark is unusually impressive.

Meanwhile, total company comparable sales ex-fuel rose 8.5% in November. That is better than October (6.6%), September (7.3%), fiscal 2018 (6.8%), fiscal 2017 (3.8%), fiscal 2016 (4%), so on and so forth, through the whole decade. Moreover, Costco’s e-commerce sales rose 34% in November, also the best mark in recent memory.

These strong numbers illustrate just how strong the U.S. consumer is right now, and show that the market’s struggles have not yet hurt consumer confidence. As long as the financial market turmoil remains contained, the U.S. consumer should remain strong, and COST should keep growing.

But let’s assume the credit market is telling us something insightful, and that the partial inversion of the yield curve does mean an economic slowdown is coming in 2019. That really isn’t awful news for COST. Costco is a low-cost provider of all sorts of goods. Consumers are always raving about the money they saved by buying a bunch of stuff at COST.

A low-cost provider that actually saves consumers money won’t get hit that hard during a slowdown. Nordstrom (NYSE:JWN) will get hit hard. Whole Foods will get hit hard. But Costco won’t. If anything, Costco’s sales should go up if consumers struggle.

So Costco stock provides a winning combination of growth and defense. This combination is highly attractive in the current environment in which investors still want exposure to growth, but also want to defend against the threat of a looming recession. Consequently, COST stock should continue to outperform the market.

The Valuation of Costco Stock Is Reasonable

Importantly, the valuation of COST stock isn’t all that overextended, considering its winning attributes.

From a big picture perspective, COST is a resilient retailer with fairly stable 5%-7% revenue growth prospects over the next several years, thanks to its large membership and share-of-wallet growth. The company’s margins are also fairly stable, and should benefit slightly from some opex leverage. These growth fundamentals imply that Costco’s EPS can reach about $14 in five years.

Costco stock normally trades at 26 times its forward earnings. Throwing a historically normal 26 forward multiple on $14 implies a four-year forward price target of $364. Discount that back by 10% per year, and you arrive at a year-end price target of just under $250.

Thus, at $230, the valuation of COST stock is reasonable.

The Bottom Line on COST Stock

Costco stock has bucked the broader market downtrend for the past two months. This trend will persist due to the company’s winning combination of growth and defense.

As of this writing, Luke Lango was long COST. 


Article printed from InvestorPlace Media, https://investorplace.com/2018/12/why-costco-stock-will-stay-strong/.

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