To The Moon

$Costco(COST)$ Stock Performance and Recent Decline Costco's stock has dropped 15% in the past few months, which is a rare occurrence for a company like this. Costco is one of the most successful stocks of all time, having increased by 13,000%. Many people, myself included, have long hoped and wished for Costco to ever trade at a reasonable multiple or rational valuation so we could invest in it for the long term. But that just doesn’t seem to happen—the stock keeps rising, and it keeps becoming more expensive. In today’s discussion, I’ll dive into Costco’s valuation to assess whether this premium is truly justified. Is Costco’s high valuation worth it? I’ll aim to come up with a fair value for the stock, one that doesn't feel like we're overpaying, especially considering the current levels. I won’t try to peg it at something like $80 by assuming a 10x earnings multiple—that’s unrealistic. Instead, I’ll work on a valuation that feels reasonable and realistic for potential investors at this level. I hope you find this analysis helpful. Costco’s Business Model and Financials Most of you are probably familiar with Costco and its wholesale clubs. The company generated $62 billion in sales, most of which comes from merchandise, and another $1.2 billion from membership fees, which are growing at 7% annually. Costco’s business model is impressive—it only has a 2.8% net margin, but it’s not about margins here; it’s about customer lifetime value. Costco has deep, loyal relationships with its customers and a wide moat that helps sustain its business. Currently, they have around 140 million members. Earnings Report and Tariff Concerns The most recent earnings report wasn’t the best. Earnings per share came in at $4.02, below the expected $4.11. However, revenue slightly beat expectations, which isn’t bad at all. I’ve talked before about the potential risks with tariffs, and that’s really my only concern for Costco—if there’s a margin squeeze or a major issue due to tariffs, it could create an opportunity to buy the stock at a lower price. The CEO mentioned that while forecasting the impact of tariffs is difficult, Costco aims to minimize cost increases for its members, meaning they might absorb some of those costs. About a third of Costco’s U.S. sales come from imports, with less than half of those from China, Mexico, and Canada. Costco has strong relationships with its suppliers, many of whom are their own private-label brands like Kirkland, so I’m not sure how tariffs will impact them in the long run. However, if Costco absorbs some of the costs and it affects their margins, that could create a potential entry point for long-term investors. Strong Growth and Performance Despite that, the business continues to perform well overall. Net sales grew 9.1%, which is impressive for a company of Costco’s size. Comparable sales grew 6.8%, with a 1% increase in average ticket size, and traffic was up 5.7%. E-commerce grew by 22%. Costco truly seems to be a gift that keeps on giving. If I were a Costco shareholder, I would hold on to my shares no matter what, even if the stock’s P/E ratio went to 50 or 60 times earnings. As import costs rise due to tariffs, Costco (COST) – along with other major U.S. retailers like Walmart – is attempting to shift some of the burden onto suppliers. This has added more pressure on Chinese exporters, who are already struggling with years of tariffs and very slim profit margins. The recent tariff hike to 20% on Chinese goods by the Trump administration has forced U.S. companies to find ways to protect their profit margins. Many are asking for price cuts, but suppliers are pushing back. A Costco supplier told the Financial Times that while larger suppliers have the "muscle" to absorb the extra costs, smaller suppliers are at risk of being squeezed out, ultimately facing significant financial strain. Costco did not respond to Quartz’s request for comment. In December 2024, Costco CEO Gary Millerchip acknowledged the impact of tariffs and mentioned that the company had taken steps such as advancing inventory purchases to stay ahead of supply chain disruptions. He also noted that if certain imported products became less competitive due to tariffs, Costco would replace them with better-value alternatives. About a quarter of Costco’s business comes from non-food items, a portion of which are imported. Millerchip also hinted that Costco might raise prices for its U.S. members, acknowledging that "tariffs raise costs," although he emphasized that this would not be a favorable outcome. Costco’s presence in China remains modest, with just seven warehouses, compared to more than 600 locations in the U.S. Cash Flow Costco is known for strong cash flow, driven largely by its steady revenue from membership fees and efficient supply chain management. The company's ability to generate cash from operations has allowed it to reinvest in growth, pay dividends, and manage its finances effectively. Valuation: High P/E and Justification Currently, Costco’s stock is trading at a P/E ratio of 52, which, at first glance, seems extremely overvalued. However, one of the biggest mistakes investors make—particularly value investors—is looking at a high P/E and immediately assuming the stock is overpriced. Yes, Costco used to trade at around 25-27 times earnings back in 2015, but that alone isn’t enough to conclude it’s overvalued now. We need to dig deeper to determine whether this multiple expansion from 25-24 times in 2013-2014 to 48 times today is actually justified. Costco's Growing Dividend Thanks to Costco's consistent revenue and net income growth, the company has established itself as a dependable dividend payer. While its annual dividend yield of 0.5% might not appeal to income-focused investors, Costco has successfully paid and increased its dividend for 20 straight years. If past trends hold, the Board of Directors is expected to announce a dividend hike to its current quarterly payout of $1.16 per share sometime in April. In addition, Costco has a strong track record of issuing special cash dividends, having paid five over the past 13 years. The most recent special dividend, a noteworthy $15 per share, was distributed in January 2024. Costco’s ability to maintain these dividends is supported by its low payout ratio and robust financial health. Its payout ratio, the percentage of earnings allocated to dividends, is a conservative 20.3%, well below the 75% threshold where companies typically face the risk of cutting or halting dividends. Moreover, Costco is debt-free and holds $7.4 billion in net cash, allowing the company to earn interest on its cash reserves rather than being burdened by interest expenses like many of its competitors. Considering these factors, it’s likely that Costco will continue to grow its dividend payments and issue special cash dividends for years to come. Net Income Margins and Business Improvement The first thing we’re going to look at is Costco’s net income margins. In the past, they were around 1.6%, but now they’re about 3%. This nearly doubling of net income margins is interesting, especially considering the increase in the stock multiple. The business has clearly become more profitable, which justifies some level of multiple expansion. While it might not fully justify a P/E ratio of 48, it does support the case for an expansion in the multiple. Return on Capital and Profitability Growth If we examine the return on capital, Costco used to see returns around 17-18%, but recently, this has risen to 24-27%, representing a significant increase. This rise in return on capital further supports the argument for a multiple expansion. Costco’s growth in earnings per share has remained relatively stable at 12-13%, sometimes up to 20%, indicating steady growth without dramatic shifts. Costco vs. Walmart: A Comparative Analysis Next, I’ll compare Costco with Walmart to provide some context. Both companies have very similar net income margins—Walmart at 3% and Costco at 2.9%. Their growth rates are also quite similar, with Costco growing around 19% in 2022 and Walmart at 17%, and both are expected to grow at similar rates in 2025 (13% for Walmart and 12% for Costco). Walmart owns Sam’s Club, which follows a similar business model to Costco. When it comes to return on capital, Costco outperforms Walmart significantly, with Costco’s return on capital at 27% compared to Walmart’s 17%. Despite these similarities, Costco’s P/E ratio is 48, while Walmart’s is 33. This significant difference in valuation is intriguing, given that both companies have similar profitability, growth, and business models. Valuation Model and Earnings Estimates For my valuation model, I’ll use analysts' estimates for earnings per share. The analysts are projecting 12% growth in 2025, 10% in 2026, and 11-13% in the following years. I believe these growth estimates are fair, and assuming Costco meets them, I expect earnings per share to reach around $28.36 in five years. Based on this, I will use a P/E ratio of 35 and 48 for my calculations. The 35 P/E is Costco’s 10-year average, while 48 represents the current valuation. Two Valuation Scenarios: Base Case and Best Case In my first scenario, assuming Costco returns to a more typical P/E of 35, we can estimate a stock price of $92 per share, which would represent just a 10% upside over the next five years. In the second scenario, assuming Costco maintains its current P/E of 48, the stock could rise to $136.1 per share, yielding a 51% upside over five years. While the latter is more appealing, I personally look for investments that offer higher potential returns. Target Entry Price for Costco Stock For me, Costco’s current price isn’t attractive enough for a long-term investment. If I wanted to start building a position in Costco, I would aim to buy shares at a price of $700 or below. At that price, you’re still paying a premium, but it's a better value compared to buying at current levels. If Costco does drop further, it could provide an even more compelling entry point for long-term investors. I highly doubt Costco will dip below $500 unless the company is significantly affected by tariffs, which seems unlikely. Therefore, I consider $700 per share a reasonable and realistic fair value. If the price falls below that, it would be a good opportunity to start a small position and dollar-cost average over time. However, if you’re not in a rush, you might prefer waiting for a potential dip to $500, though it’s hard to predict when or if that will happen. This is just my perspective on Costco’s stock. Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose. @Daily_Discussion @TigerPM @TigerObserver @Tiger_comments @TigerClub