Shares of Costco Wholesale (NASDAQ:COST) have broken out to new highs, as investors pile into this best-in-class retailer. While other names were enjoying their time in the sun, Costco stock was lagging. However, the recent breakout has investors taking another look.
Near the end of June, the stock firmed up before clocking nine straight days of gains. After such a run, Costco didn’t embark on a nasty pullback. Instead, it has chopped sideways, allowing investors to digest the latest breakout.
Will that eventually yield to another move higher? If the broader market remains intact, then the probabilities favor the bulls. Let’s look at why Costco is in such a prime position for investors right now — even without the charts.
Costco has a Moat
Last month, we talked about Warren Buffett and his love of moats. In that discussion, I mentioned that Buffett’s firm does indeed have a “small” stake in Costco … worth just over $1 billion. However, that’s less than 1% of Berkshire Hathaway’s (NYSE:BRK.A, NYSE:BRK.B) portfolio.
That’s not the important part, though. What’s important are the attributes that would attract Buffett to Costco stock in the first place. In this case, it’s Costco’s consistency and its moat.
What is this moat, anyway? It’s the company’s ability to generate revenue even before it sells one item at its stores. That’s the membership fee revenue. With a 90% renewal rate, investors have come to depend on this high-margin cash flow unit, which allows Costco to operate from a position of strength.
In essence, it’s operating out of the green before it even has to get into the commerce portion of the business. With a modest markup on its products, consumers see attractive savings passed along to them, while Costco makes a small profit on the sale and keeps banking those annual membership revenues. In that article, I wrote:
“This recurring revenue stream is more akin to a software company, which really commands a high valuation. In other words, Costco is like a software company masquerading as a retailer and this makes its stock look cheap in comparison.”
An annual membership isn’t the end-all, be-all of retail. But it helps justify why Costco stock commands a higher valuation than some of its peers like Walmart (NYSE:WMT) and Kroger (NYSE:KR).
Trading Costco Stock
As you can see on the chart to the right, Costco stock continued to find support near the 200-day moving average and the $297 level. Eventually, though, shares caught fire.
Click to Enlarge
The stock rallied hard off this level, reclaiming the 20-day and 50-day moving averages and breaking out over $320 and downtrend resistance (blue line). Now consolidating under $328, Costco shares have the setup to continue higher if the stock can find more momentum.
On the upside, traders may turn their attention to the 123.6% and 138.2% extensions, up at $337.23 and $345.09. Above that and investors will likely look for a push to $350 — a psychologically relevant level — followed by the 161.8% extension at $357.80.
On the downside, I’d love to see Costco stock hold up over the 10-day moving average and the $320 breakout level. Below that and prior downtrend resistance could be retested, followed by the 50-day moving average.
For now though, the ball is in the bulls’ court.
Bottom Line on COST Stock
In a world where the novel coronavirus is disrupting the entire economy, the retail sector is made up of the haves and the have-nots. Fortunately for investors, Costco stock is among the former.
As the “pantry rush” was playing out during peak coronavirus panic, Costco, Walmart, Kroger, Target (NYSE:TGT) and others saw a rush of buyers as consumers stocked up on household goods. That said, Costco does not have robust earnings growth as it has had to absorb elevated costs related to Covid-19 operations.
Analysts expect 7.3% revenue growth this year and 6.3% growth next year. On the earnings front, consensus estimates call for 3.2% growth this year and an acceleration up to 10.1% growth in 2021.
In other words? Even a pandemic couldn’t really disrupt Costco. The fundamentals are there, as are the technicals. Bulls are in control for now.
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.
