Costco: Record Valuations Contrast With Slow Growth Outlook

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Costco's stock is trading at a higher PE ratio than at its 2000 peak, even as profit margins are at record highs.The high PE ratio contrasts with the relatively weak outlook for earnings growth ...

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href=https://seekingalpha.com/article/4684480-costco-record-valuations-contrast-with-slow-growth-outlook><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Costco's stock is trading at a higher PE ratio than at its 2000 peak, even as profit margins are at record highs.The high PE ratio contrasts with the relatively weak outlook for earnings growth ...</p>\n\n<a href=\"https://seekingalpha.com/article/4684480-costco-record-valuations-contrast-with-slow-growth-outlook\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"LU0308772762.SGD","symbol_name":"Blackrock Global Allocation A2 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expenses, while gross margins are trending lower.NoDerog/iStock Unreleased via Getty Images Costco's (NASDAQ:COST) stock is now among the most overvalued of all US mega-cap stocks, trading at a higher PE ratio than its 2000 peak, which gave way to a decline in excess of 50% and a decade of negative returns. Such extreme valuation multiples make little sense to me given the company's mediocre expected growth rate, and a move back to fair value based on discounted cash flows could easily cause the stock to lose over half of its value. In the highly competitive retail market, there is little scope for Costco to scale its margins and accelerate revenues, yet this is what investors appear to be relying on if they are to achieve positive long-term returns on the stock. The 3rd Most Expensive US Mega Cap Costco is now trading at a price to earnings ratio that marginally exceeds its 2000 bubble peak, with a PE ratio of 45x and a price to free cash flow ratio of 51x. These profit multiples are even more noteworthy when considering that the company's profit margins are at record highs. On a price to sales basis, the stock is 60% more overvalued than at its 2000 peak. Costco PE and PS Ratios (Bloomberg) The chart below shows the valuation multiples for the S&P 500 mega-cap stocks, defined as stocks with a market capitalization of above $200bn. The multiples are based on an average of the forward PE ratio and the forward price to free cash flow ratio, excluding stock-based compensation. On this basis, Costco ranks as the third most expensive stock behind only Tesla (TSLA), Eli Lilly (LLY), two stocks which I have recently assigned sell ratings on here and here. Bloomberg Comparing company valuations across different sectors is difficult due to varying industry growth rates, profit margins, and risk profiles, but as I argued in a recent article on Microsoft, large companies tend to trade at discounted valuations due to weaker growth prospects. As shown below, a handful of mega-cap tech stocks in blue currently buck this trend due to their monopoly positions. However, Costco is also firmly in the overvalued section of this chart. In fact, only Tesla and Amazon (AMZN) have a combined higher trailing PE ratio and higher trailing nominal earnings. Bloomberg One would assume that investors must be anticipating strong sales and earnings growth to justify Costco's valuation, but Wall Street analysts see just 7% revenue growth and 9% earnings growth for the company over the next 12 months. As can be seen in the chart below, Costco stands out as being extremely expensive yet with a notably slow growth rate relative to its peers. The only other stocks with a higher forward PE ratio are Tesla and Eli Lilly, where earnings are expected to grow by 33% and 45%, respectively, next year. Bloomberg Margin Improvement Unsustainable One positive dynamic that appears to attract investor interest has been the rise in profit margins, which have been on a relentless rise over recent years, reaching a record high of 2.8%. However, the margin increase appears to have been the result of economies of scale where relatively fixed selling, general, and administrative expenses have fallen as a share of revenues as the company has expanded. EBITDA margins have actually been in decline since 2020, meaning that the bulk of the net margin increase has resulted from a fall in the cost of non-operating expenses relative to sales. Furthermore, gross margins have actually seen a sharp decline since the pre-Covid era, as the company's expansion has come at the expense of margins. These factors strongly suggest that Costco's net profit margins will struggle to continue their rise, and may even have already reached a peak. Costco Profit Margins (Bloomberg) Fair Value Is Significantly Below Current Levels Discounted cash flow analysis put Costco's fair value at less than half of current levels. I will assume that earnings and free cash flows grow at 9% annually over the next 10 years before slowing to the rate of GDP growth of around 4%. The below table shows the respective fair value estimates depending on the required rate of return. Using a 10% required rate of return in line with the long-term returns on US stocks puts Costco's fair value 67% below current levels. Even with a required rate of return of 8.5% the stock is still 100% overvalued. These forecasts also assume that all the company's free cash flows are returned to shareholders in the form of dividends and buybacks.        Required Rate of Return 10.0% 8.5% 7.0%   Current Market Cap, USD bn 318 318 318   Current FCF Ex SBC 5.8 5.8 5.8   FCF Yield 1.8% 1.8% 1.8%   Growth Rate For Next 10 Years 9.0% 9.0% 9.0%   Growth Rate Thereafter 4.0% 4.0% 4.0%   FCF in 2034, USD bn 13.7 14 14   Fair Value Market Cap in 2034, USD bn 229 305 458   PV Fair Value Market Cap, USD bn 104 160 276   % Decline Required To Return To FV -67% -50% -9%   Click to enlarge Summary  Costco's PE multiple is now higher than at its 2000 bubble peak, while its price to sales ratio is significantly higher. Stocks that trade at 50x earnings tend to have monopoly characteristics and strong growth prospects, but Costco does not appear to have either, making it an outlier among mega-cap US stocks. The rise in profit margins is unlikely to continue as gross margins face downside pressure from tight competition, and even assuming industry-beating profit growth over the coming years, fair value for the stock is at least 50% below current levels.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2428251124"}