This year’s Super Bowl between the Kansas City Chiefs and the San Francisco 49ers had an over/under of 54.5 points. Looking at the average target price of analysts covering Costco (NASDAQ:COST) as the over/under for Costco stock, it’s currently $312.
Up 48.4% over the past year, including dividends, the warehouse chain has gotten off to a strong start in 2020, delivering a total return year to date of 5.3% through January 30, considerably higher than the -1.8% total return for the Morningstar US Market Index.
As Clint Eastwood would say, do you feel lucky, punk? Do you think Costco’s actual value is above $312 or below?
Costco Stock Is Worth Far More Than $312
As I write this, Costco is trading within six dollars of its all-time high. Looking back to January 2008, Costco’s had three significant corrections: May 2008 to February 2009 (-42%), June 2017 to July 2017 (-17%), and November 2018 to December 2018 (-18%).
In 11 years, it’s had just three corrections of more than 15%. If you bought Costco stock in May 2008, before the entire stock market collapsed, you’d have a compound annual growth rate of 14.1%, not including dividends. If you bought the SPDR S&P 500 ETF (NYSEARCA:SPY), your CAGR would only be 7.8% (630 basis points higher than the index).
Over the next 11 years, I believe Costco will continue to wipe the floor with the index. Here’s why.
People Love Shopping At Costco
My wife and I used to live in Toronto. To get to a Costco in the Greater Toronto Area (more than 5 million people) was a major headache, so we didn’t go that much. Now that we’ve moved to Halifax (population 400,000), it’s so much easier to get to the two local Costco’s. Not to mention, once there, it’s not nearly as hectic.
As a result, we’re there at least twice a month. We love the place, although the only piece of clothing I’ve ever bought there is a bunch of black socks. It’s the food and packaged goods that keep us going back.
It turns out celebrities also like Costco.
The Business Insider recently ran a fun story about 12 celebrities who love shopping at Costco. At the top of the story was a TMZ tweet with a picture of Facebook (NASDAQ:FB) CEO and co-founder Mark Zuckerberg shopping with his wife, Priscilla. It appears they were looking at TVs.
All joking aside, Zuckerberg’s visit shows how sticky Costco’s value proposition is with those more affluent. In good times, the well-to-do go to Costco to find products not usually available; in bad times, they go to save a little. I would think very few would switch from Costco to Walmart (NYSE:WMT) in economic downturns.
In the 36 months between Sept. 3, 2007, and Aug. 29, 2010, Costco’s three-year same-store sales stack was 11% overall on a global basis. In its worst year (fiscal 2009), during the height of the recession, its same-store sales fell by just 2% in the U.S. Internationally, they fell by 8%.
For reasons I can’t understand, Walmart doesn’t include same-store sales figures for Walmart International. In the U.S., the retailer’s same-store sales fell by 0.8% in 2010, rose 3.5% in fiscal 2009, and up 1.6% in 2008, for a three-year same-store sales stack of 4.3%.
Long-term, Costco’s wealthier demographic — shoppers with an average annual income of $100,000+ vs. $76,000 for Walmart — should ensure that its stock continues to outpace Walmart’s. Over the past decade, Costco’s generated an annualized total return of 19.6%, double the performance of Walmart’s stock. For this reason, the over should win the day.
I’ll Bet the Under
I have only two arguments for betting on the under proposition — and they’re not very convincing.
The first has to do with reversion to the mean. CNBC commentator Bob Pisani discussed the subject in an article this past December.
“No one knows for sure, but on a sector level, history implies (but does not guarantee) that the best sectors in the prior decade will not repeat as leaders in the coming decade,” Pisani quoted a note written to clients by Sam Stovall, chief investment strategist at CFRA.
Pisani went on to explain that mean reversion is “the tendency for most investments to revert to long-term averages.”
Extrapolated to the Walmart and Costco example, Costco’s outperformance over the next decade, due to mean reversion, is far from guaranteed.
The second argument is that some unexpected economic event occurs that sends all stocks into a crash scenario reminiscent of the 2008 recession. Perhaps the current stir over China’s coronavirus, which the World Health Organization has called a global emergency, will send vast swaths of investors scurrying to cash.
Or, given the U.S. has logged the second consecutive year of sub-3% GDP growth, a recession may be just around the corner.
Other than that, perhaps its valuation is stretched at 22 times its forward price-to-earnings ratio, but even there, it’s not an outrageous multiple for one of retail’s best businesses.
The Bottom Line On Costco Stock
In August 2018, I discussed whether Charlie Munger, the sidekick to Warren Buffett and a long-time director of Costco, should buy more of Costco’s stock. Trading at $223, I was emphatic that he should.
Up 38% since then, I don’t believe there’s ever a wrong time to buy the company’s stock.
So for me, I’ve got to go with over $312.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.