Looking to bargain hunt? You may find what you’re looking for inside Costco (NASDAQ:COST). But when it comes to a more expensive-looking Costco stock, investors should position themselves ahead of the crowd with a risk-adjusted collar purchase.
The broader market, led by the Nasdaq Composite, has been nothing short of breathtaking in 2020. Prior to and into the March Covid-19-driven bottom, the index took our collective breath away in the worst sort of way. Now, a handful of months later, with the barometer up 24% on the year at record highs and roughly 70% above its historic low, it’s equally captivating.
Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN) receive a large part of the credit behind the Nasdaq’s performance. And for good reason. They’ve returned 33% to 72% this year. They also sport massive market capitalizations and make up a huge potion of the muscle within the index. Appreciating the trio’s importance with Wall Street and consumers is easy and scary all at the same time.
They’re not alone in those regards though.
In its own measurable ways, Nasdaq constituent Costco stock is also a popular and pricey proposition. A year-to-date gain of about 16% doesn’t sound threatening. Nor by comparison does a capitalization of around $150 billion amid stockpiling in bulk of items like toilet paper and foodstuff by Americans in 2020. But COST stock is trendy and expensive.
Shares of Costco currently sport a forward price-earnings ratio of 36 versus a multiple of 26x for Walmart (NYSE:WMT) and 12x for grocery giant Kroger (NYSE:KR). And priced more than four times the company’s earnings growth and meager operating margins of just 3.2%, it’s becoming riskier for investors to defend Costco as a “premium investment that deserves a premium price.”
Still, could Costco’s most recent quarterly results, now a full couple months in the rearview mirror, be a one-off? Could the late May report be a weak representation of today’s business environment, which already looks a good deal different? I say don’t bet against the house — or in this case, the warehouse.
Costco Stock Monthly Price Chart
Source: Charts by TradingView
On the price chart, I’d argue Costco remains a friendly-looking investment. And it’s easy to defend. The extended monthly view shows a stock that has improved its tenacity with a handful of increasingly determined uptrend lines, but not enough to cause alarm. Not yet, at least.
I’m most interested in Costco stock’s uptrend, which began in late 2018. At an eyeballed slope of around 45 degrees, the commitment from investors in both absolute and relative terms is approachable without being worryingly steep. Moreover, shares broke out of a healthy base-on-base pattern near $324 in July backed by a neutral positioned stochastics that’s beginning to trend higher. Net, net, the price action is bullish.
What would be frightening? If the breakout, now roughly 5% beneath current prices, unfolds into a more severe uptrend, I’d be worried. (Of course, open profits are a nice concern to deal with.) Alternatively, I’d be concerned if today’s bullish trend is jeopardized with bearish action on the price chart. In our estimation, that occurs if Costco shares fall 12%.
From current levels near $340, a 12% decline puts Costco at $298. It’s an important warning for multiple reasons. First, shares would be underwater by 8% from the original pattern breakout of $324. Most investors will agree that’s enough wiggle room for this kind of purchase.
Second, at a price of $298, Costco would be beneath whole-number support of $300. That could spell extra overhead supply from other investors.
Lastly, 2018’s trend-line support would have narrowly failed.
So, how might today’s investors approach a purchase of Costco stock? I’d suggest an ironclad insurance policy slightly above technical support to avoid a crowd capable of smashing right through the exit. This can be accomplished with a hedged collar strategy. One favored spread of this type is the October $310 put/$390 call combination priced for $342.30.
Chris Tyler is a former floor-based, derivatives market maker on the American and Pacific exchanges. Investment accounts under Mr. Tyler’s management do not own any securities mentioned in this article. The information offered is based on his professional experience but strictly intended for educational purposes only. Any use of this information is 100% the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT and StockTwits.