Thursday was painful for the bulls on Wall Street. Ironically, the riskiest of them all GameStop (NYSE:GME) was up big. The word is that its sharp rallies may have contributed to the downside in indices. Speculators shorting it may have had to sell good stocks to cover their losses in GME. Regardless, “red” happens as part of normal price action. More on this later. Today’s focus is to determine if Costco (NASDAQ:COST) is a knife worth catching. COST stock has value and at some point that plays a big factor.
Yes, is my short answer.
But first we have to acknowledge the fact that equity markets are in danger. We’ve been on a bullish run way too long and under terrible conditions. What’s propping us up are the artificial measures and the trillions of dollars from the government. The magnitudes of the safety programs they’ve deployed are enormous. This should tell us that there’s something wrong.
Nevertheless, the safety nets are out so the bulls are comfortable. They say BTFD (buy the f—— dip), from what I gather Thursday’s action was indeed a “freaking” dip. I expect the bulls to step up soon.
Costco stock has given back a lot of its upside already. It’s down 15% from its recent highs. Fundamentally, it’s cheap and that should lend it support. It has a reasonable price-to-earnings ratio of 35 and a price-to-sales under 1.
Owners of the stock today give it less than one year’s worth sales in credit. Meaning, they don’t have a lot of hopium built into COST stock price. That makes the investors hard to disappoint. In any case, management has been beyond reproach. They were quick to act and adjust for operating under quarantine rules. I felt safe walking around their stores since this mess started. That’s why they’ve been busier than ever.
COST Stock Has Support
Technically, the stock triggered a bearish pattern once it lost $350 per share. The downside target of this could extend $13 lower than yesterday’s close. However, the whole zone between here and there is supportive. This has been the area in contention since last March. Pivot ranges like this usually serve as support for prices.
I believe the easy work for the bears is over. For more significant downside they are going to need to work a lot harder. Coming down from almost $400 per share is easy, digging deeper here is not.
On the other hand, having support and value doesn’t mean it will experience an immediate recovery. New investors expect everything to bounce in a V-shape. I’m here to remind them that that is not the norm. Bottoming should be a process, not a flashpoint event. This is to say that on the way up there will be resistances. This will be especially true when it approaches the $350 neckline. There will be sellers lurking.
Create a Buffer Zone
On bad days like Thursday when COST stock was falling precipitously, I prefer selling puts rather than buying shares outright. In addition to falling stock prices, The CBOE Volatility Index (VIX) exploded 35% up. This balloons put option prices making my safety net even bigger.
For example, instead of spending $33,400 to buy 100 shares of COST stock, I would have sold the April $300 put. For this I would collect a net credit of $300. In return I promise to buy the shares at $300 each. If that happens my break-even point for owning them would be $297. In comparison, someone who bought the shares outright would be down 11% when I break even.
I don’t sell puts in a stock that I don’t want to own shares. I have great confidence that Costco stock long term makes for a sane financial decision. During the pandemic crash, the stock traded heavily between $320 and $290 per share. Support like this is a solid floor even on the worst of days. The stock could fall all the way down to that but I think that would need depression-like conditions.
The pandemic shutdowns should be as bad a test as it gets for decades. No one was working on the entire planet and those are conditions that are hard to match. If COST stock bounces and then fails to hold $330 per share, a second leg lower then starts. The downside risk from that would take it closer to $310 per share. This is not my forecast but it is a scenario that the bulls need to acknowledge exists.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.