Costco’s shares returned nearly twice as much as the S&P 500 in the first half of the year, but investors have pushed the stock to an extreme valuation.
Costco Wholesale‘s (COST 0.38%) stock had a particularly good first half of 2024, rising nearly 29%. That’s roughly twice the gain of the S&P 500 index over that time frame. Before you’re lured in by the stock’s obvious momentum, you might want to step back and check out the business you are buying — and especially how much you are paying for it.
Costco has another strong quarter
Costco’s fiscal year doesn’t end in December, so its earnings get reported a little off the typical cadence that many companies follow. Thus, in late May, it posted fiscal third-quarter 2024 financial results. The numbers were pretty good, which isn’t at all surprising given the long-term success the club store retailer has achieved.
Image source: Getty Images.
Sales rose 9.1% year over year. On the bottom line, net income per share was $3.78, up from $2.93 in the prior-year period. To be fair, the third quarter of fiscal 2023 included a $0.50-per-share one-time charge, so the increase wasn’t quite as big as it first seems. But earnings still rose nicely, even taking the charge into account.
Also of note, given the sector in which Costco operates, were same-store sales. The top line includes both existing locations and new stores, while same-store sales only factor in the performance of locations open for at least a year. The company’s same-store sales rose 6.6% in the quarter, which means its older locations continue to operate at a high level. E-commerce revenue increased a huge 20.7%, but this is just a small slice of Costco’s business.
What are you paying for Costco shares?
Looking at Costco’s fiscal third-quarter financial results, you can see why investors would be upbeat about the stock so far in 2024. And yet, you shouldn’t ignore the price tag being paid for a company. To paraphrase Benjamin Graham, the man who taught Warren Buffett all about value investing, paying too much for a good company can turn it into a bad investment.
On the valuation front, Costco is starting to look a bit stretched. Each of the traditional valuation metrics — price-to-sales, price-to-earnings (P/E), price-to-book value, and price-to-cash flow — are well above their five-year averages. To cite just one example, Costco’s current P/E ratio is an eye-watering 52 compared to a five-year average of roughly 40. But 40 is already a pretty elevated number considering that the average P/E for the S&P 500 is closer to 23 right now. SPDR S&P Retail ETF, which tracks the broader retail sector, has an average P/E of only about 14.
Think about that for one second: Costco’s P/E ratio of 52 is well over 3 times the P/E of the average retail stock. This suggests that investors are pricing in a lot of good news at Costco. Any shortfall relative to expectations, even a modest one, could lead investors to dump the shares. And if there’s a bear market, it is likely that Costco will be particularly hard hit given its impressive rally.
That’s where the graph above comes in. Costco’s share price and P/E are both near all-time highs. While it is possible that the stock keeps rallying in the second half of the year, investors with even the slightest concern about valuation probably won’t want to own it.
A great company at too dear a price
Costco is a very well-run company, and all of Wall Street knows it. That’s a problem for any new positions in the stock, given the massive premium the shares have been afforded. Most investors will probably want to keep Costco on their wish list for the next big pullback in the shares when, with any luck, the valuation won’t look so stretched.
