A standout stock that has performed exceptionally well recently is not related to the technology industry or the current surge in artificial intelligence (AI). I am referring to Costco ( COST -0.24% ) The stocks of the warehouse club company have generated a cumulative return of 233% over the last five years, surpassing the others. S&P 500 by 96%.
While the retail stock While Costco has been performing well in 2024, I am not optimistic about its future performance. I anticipate that Costco’s performance will be below that of the S&P 500 over the next five years.
Costco is a reputable business.
Initially, it is crucial to establish the right mood. Costco is a highly reputable company with numerous favorable qualities that are valued by investors.
Costco, ranked as the third largest retailer globally, benefits greatly from its large scale. With high sales volume and a limited number of products in its stores, the company can use its significant purchasing power to negotiate better prices with suppliers, leading to cost savings. These savings are then reflected in the form of affordable prices for customers on a daily basis.
This benefit enhances the resilience of Costco’s business, reducing the likelihood of disruption. Moreover, the company’s subscription-based system generates a consistent and profitable revenue stream with a high profit margin. With a global retention rate of 90.5% in the most recent fiscal quarter (Q3 2024 ending on May 12), it is evident that customers exhibit strong loyalty.
Warren Buffett’s close associate, who has passed away Charlie Munger Munger was a big supporter of Costco, expressing his affection for the company by stating, “I adore everything about Costco and have no intention of ever selling my shares.”
Where is the level of protection?
The stable and reliable financial results, specifically the consistent increase in revenue and earnings over a prolonged period, have made Costco’s stock a preferred choice among investors. However, in my opinion, the market’s strong enthusiasm for the company may be excessive.
Now let’s discuss the importance of valuation, which is a crucial factor in an investor’s assessment. Currently, Costco’s stock is being traded at The ratio of a company’s stock price to its earnings per share is known as price-to-earnings. The current price-to-earnings ratio (P/E) is 52.9. The highest P/E ratio it has ever reached was 56.4 back in 1999. The stock is considered highly overvalued at present, and it is unlikely that anyone would argue otherwise.
There is absolutely nothing The difference between the actual or current value of an investment and its intrinsic value, providing a cushion in case of unforeseen events or changes in the market. The current stock price already includes the belief that Costco is infallible, so there is significant risk of a drop in value. If Costco falls short of Wall Street’s expectations even slightly or if investors become slightly less positive about its future, the stock could plummet, resulting in losses for portfolios.
If Costco was expected to significantly boost its profits quickly, it could be justified to pay 53 times its earnings. However, this is not the current situation. Analysts predict that the company will experience a 10.7% annual growth in earnings per share from fiscal 2023 to fiscal 2026. Given that Costco is a large and well-established company, it is likely that its growth will slow down as it matures.
Sharp readers may challenge my claim that the stock is overpriced by pointing out that this has consistently been true. To illustrate, a decade ago, stocks were valued at a P/E ratio of 26.6, which was considered costly at the time. However, since then, stock prices have increased by 616%.
It is important to note that the price-to-earnings ratio increased by almost 100% during that period. Is it reasonable for a prudent investor to anticipate that Costco’s stock will not only experience a similar doubling of the P/E ratio, but also any further increase in multiples within the next five years? I am of the opinion that there is a high probability the valuation ratio will decrease.
I believe that investors will face a strong resistance due to this, leading to the stock performing below the overall market until 2029.
