Costco Is Dead Money (NASDAQ:COST)

Introduction

Amid parabolic stock moves in the technology sector, the murmurs of an AI bubble are growing louder and louder; however, nosebleed stock valuations are not limited to the Nvidias of the world. Costco Wholesale Corporation (NASDAQ:COST), a mature retail giant, is up ~50% over the last year, building on top of a parabolic rally in its stock during the liquidity bubble of 2020-21.

Based on price action, Nvidia [of 2023-24] and Cisco [of 2000] look eerily similar. That said, in my view, Costco’s parabolic ascent is even scarier. Despite growing its top line at a mid-single-digit rate, Costco currently boasts an exorbitant forward P/E multiple of ~46x. To put this valuation in perspective, Nvidia trades at a forward P/E multiple of ~36x and is growing way, way faster than Costco.

Alright, comparing Costco to Nvidia is probably unfair, but comparing Costco to itself is fair game! As you can see below, Costco is trading well above its historical median P/E ratios, and we are getting pretty close to the 1999 peak valuation for COST stock.

While we may or may not be in an artificial intelligence bubble, Costco certainly appears to be bubblicious. Let’s perform a reverse DCF analysis on COST stock to see what Mr. Market is currently pricing into the retail giant!

Reverse DCF Exercise For Costco Stock

For this reverse DCF exercise, we have used a 5-year modeling period and generous assumptions for steady-state free cash flow margin [+3%] and terminal growth rate [+5%]. While these model assumptions are quite straightforward, please feel free to share your thoughts or concerns in the comments section below.

Based on its current stock price of ~$732 per share, Mr. Market is currently pricing in a 5-year CAGR revenue growth rate of ~23% into Costco’s stock!

Does The Implied Growth Make Sense?

Given Costco’s mid-single-digit growth rates, the market pricing in ~5x faster growth into COST stock for the next five years is simply ridiculous. Yes, Costco is a serial growth compounder; however, such pricing is a tell-tale sign of irrational exuberance in the stock market.

After recording healthy double-digit top-line growth during the inflationary wave in 2020-22, Costco has seen its growth rates slow back down to mid-single digits over recent quarters. And, according to consensus street estimates, Costco is projected to compound sales growth at 6-7% per year for the next 5 years.

In QQQ: Prepare for Turbulence, I highlighted the role of abundant liquidity in the ongoing meltdown in financial markets. If liquidity dries up, Costco’s stock could struggle big time, as investor expectations built into the stock are completely out of touch with business reality. Costco is a mature (slow-growing) retailer priced for hypergrowth.

Let us now look at a more reasonable valuation for Costco:

Costco Fair Value And Expected Return

Considering Costco’s footprint expansion plans of 25-30 clubs per year and comparable store sales growth of 3-5% per year, I believe Costco can deliver 6-9% CAGR sales growth over the next five years. While our growth assumption is slightly higher than street estimates, I think a 7.5% CAGR sales growth assumption is reasonable.

As you can see above, Costco’s fair value is ~$394 per share, which implies a downside of roughly 46% from current levels. Assuming a somewhat generous P/FCF exit multiple of ~25x, we get to a 5-year price target of ~$713 per share, which implies a CAGR return of -0.53%.

At current levels, Costco stock looks like dead money for the next five years. With COST’s base case expected CAGR falling well short of my investment hurdle rate (of 15% per year) and long-term market (SPY) returns (of 8%-10% per year), I rate COST stock a “Sell” at $732.63 per share.

With animal spirits running wild in the stock market, making a “Sell” call on a winning stock like Costco is hard. However, the incredible rally in COST has rendered the stock dead money for the next five years. Remember, nobody ever lost money taking a profit!

Key Takeaway: I rate Costco a “Sell” in the mid-$700s.

Thank you for reading, and happy investing! Please share any questions, thoughts, and/or concerns in the comments section below or DM me.