The Historical Costco Premium Is Getting Downright Silly

Barron’s recently reported that Guggenheim analyst John Heinbockel felt that Costco’s (NASDAQ:COST) historical earnings premium was getting ahead of itself at 36 times 2021 earnings. For this reason, Heinbockel isn’t recommending his clients buy Costco stock at current prices.

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Up 21% year to date, is he right? 

While I love Costco’s business model, it’s hard to argue with his rationale. But I’m going to try. 

The Analyst’s Take on Costco Stock

As Barron’s reported, Costco has a five-year average price-earnings ratio of 29 and a price-to-EBITDA of 15. At present, the multiple, as stated in the beginning, is 36, while the multiple for the latter is 19. 

“Although Costco has traded at a premium to other retailers, given the steadily growing nature of its business, he [Heinbockel] notes that the stock’s multiple is well above historical levels,” Barron’s contributor Teresa Rivas wrote Oct. 1. 

“The shares trade at more than 36x his 2021 earnings-per-share estimates, compared with a five-year average of 29x; it’s at more than 19x 2021 EBITDA (earnings before interest, taxes, depreciation, and amortization), compared with 15x historically. That keeps him on the sidelines ‘despite our view that Costco remains well positioned on a secular basis.’”

Heinbockel isn’t the only analyst with a valuation concern. Of the 34 analysts covering Costco, only 19 have it as a buy or overweight, with the rest at hold or underweight. Further, the average target price of $363.48 is less than $10 higher than its current price.

That’s a 12-month target, which means most analysts, including Heinbockel, believe the good news is already priced into its share price. In other words, COST could be dead money in 2021. 

In August, InvestorPlace contributor Ian Bezek called Costco “a great company, but an expensive stock.” 

“Alas, as great as the business is going right now, it’s hard to get excited about Costco’s stock here. That’s because, at this time, Costco is selling for 39x trailing earnings,” Bezek wrote Aug. 19. “For the year ahead, analysts see earnings jumping around 10% to $9.41 per share. That would put the stock at 35x forward earnings.”

Essentially, Bezek said in August, what Heinbockel is saying today. In the six weeks since, COST stock has gained another 4%, making it even more expensive heading into the final quarter of 2020. 

Costco Is Worth Buying At Any Price

OK, maybe not at any price, but certainly at $355 if you’re planning to own for three to five years. 

In February, the average target price for COST was $312. I wondered whether its actual value was above or below $312.  

“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,” I wrote on Feb. 3. “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.”

Since my article, Costco gained 17%. More importantly, the 12-month target price has increased by about the same amount. What are the odds that analysts will up it to over $400 before the end of the year? I’d say pretty good.

Heinbockel actually makes a case for another hike.

“‘Beyond September, we believe the setup through year-end is solid, especially for a consumables-led value retailer that is historically early entering seasonal categories. The trend of people eating at home more often should benefit the business, while e-commerce gains and strong holiday execution are additional tailwinds. That leads him to expect core comparables of 10% through the end of the year.”

I can remember when people questioned whether Costco would be able to build an online business. In the 52 weeks ended Aug. 30, the company’s e-commerce comparable sales grew by 50.1%. At the end of 2019, online sales accounted for approximately 4% of revenue. Investors should expect this percentage to continue to grow. 

The Bottom Line

I remain a big fan of Costco stock. 

So, despite Costco’s valuation getting downright silly, I would argue for anyone considering purchasing its stock to buy a half position today and keep the rest on the sidelines if the markets correct in the next three to six months. 

As retail stocks go, Costco is the gold standard. And expensive to boot. 

On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.


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