Warehouse mega-retailer Costco (NASDAQ:COST) is set to report fourth-quarter numbers after the bell today, Oct. 3, and there’s plenty of data out there supporting the notion that the numbers will be very good. But, Costco stock has rallied big ahead of this earnings report, so now the question becomes: will strong fourth-quarter numbers be enough to spark a rally in Costco stock?
I’m cautious. I think there’s very little doubt that Costco’s numbers will top estimates by a healthy margin. Foot traffic data, macroeconomic data, web traffic data, and Costco’s own sales reports imply that the numbers will be very good. But, management could sound a more cautious tone on the conference call than investors are expecting, given recent slowing service economy trends. And at well over 30-times forward earnings, Costco stock isn’t priced for a cautious tone.
In other words, the valuation underlying Costco stock implies that Costco earnings have to be perfect from head to toe to warrant a post-earnings rally in the stock. Perfection likely won’t happen. If it doesn’t, Costco stock could be subject to a post-earnings dip.
That’s why I’m cautious here. Long-term, COST stock is a winner. In the near term, though, expectations appear to be too super-charged for their own good.
Strong Data Implies Costco Earnings Will Be Good
There’s plenty of data out there which implies that Costco earnings will be very good.
First, foot traffic data from Placer.ai — the world’s most advanced foot traffic analytics platform which leverages smartphone tracking and AI to estimate in-store traffic volumes — implies that Costco stores remain very busy. According to Placer.ai, July 2019 visits rose 4.3% year-over-year nationwide, while August 2019 visits rose a more impressive 10.9% nationwide. As Placer.ai’s Ethan Chernofsky, VP of Marketing, puts it: “While this acceleration may not continue, the ability to drive growth on this level speaks to a brand that is continuously figuring out how to maximize their retail footprint.”
Second, Costco’s own sales reports corroborate healthy Placer.ai foot traffic data. Specifically, Costco has said that global comps rose 5.1% in May, 5.3% in June and July, and 5.9% in August. Thus, not only is Costco growing at a steady and healthy pace, but that growth is actually accelerating higher. Even further, August’s 5.9% comparable sales gain is the best monthly comp Costco has reported since January 2019.
Third, macroeconomic data remains broadly supportive here. Retail sales in the three month stretch of June, July, and August rose a healthy 4% year-over-year, while the ISM non-manufacturing PMI has been above 50 all year long (representing services sector expansion).
Fourth, web traffic data supports the idea that Costco continues to grow mind-share on the e-commerce front. Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google Trends search interest data shows that search interest volume with respect to Costco has continued to climb higher in the past year, implying that more people are searching for (and presumably shopping on) Costco.com.
Big picture: all the important trends remain favorable for Costco, implying that Costco’s fourth quarter numbers should be very good.
Costco Stock Is Priced for Perfection
Although Costco earnings may be good, strong fourth quarter numbers may not be enough by themselves to spark a post-earnings rally in COST stock.
Why? Because Costco stock is priced for perfection. The stock currently trades at 33-times forward earnings. That’s about as rich as the valuation for Costco stock has ever been in the past decade. It also represents a huge premium to the consumer discretionary sector average forward earnings multiple of roughly 21. It also seems out of whack with the company’s growth profile (mid-to-high single-digit revenue growth, with flattish margins, some buybacks, and low double-digit profit growth).
With the stock priced for perfection, Costco stock needs its Q4 report to be perfect from head to toe. That’s a tall order. Perfect earnings reports are hard to come by.
This report looks especially susceptible to weakness. The recent much weaker-than-expected non-manufacturing PMI for September shows that the U.S. services economy — which has been resilient to the trade war thus far thanks to strong labor conditions — is starting to buckle under the weight of immense geopolitical pressure. Costco management may speak to this trend on the conference call. In so doing, they may sound a cautious tone with respect to go-forward growth prospects.
Costco stock isn’t priced for a cautious tone on the call. As such, a cautious tone could hit Costco stock hard.
Bottom Line on COST Stock
Costco stock is a long-term winner, and the company will report strong fourth quarter numbers. But, in the near term, COST stock is priced for perfection, and strong fourth quarter numbers may not be enough to support the stock’s hyper-rich valuation.
Because of this, while I expect Costco earnings to be good, I don’t expect much of a post-earnings pop out of COST stock.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
