Costco (NASDAQ:COST) rounded off another solid quarter. It continues to exhibit why COST stock is perhaps the best of breed in the food and staples retail sector.
However, its valuation continues to grow rapidly and seems divorced from its fundamentals and future outlook. With COST stock trading at over 27x forward cash flows, it’s best to wait for a likely correction before investing in it.
There’s no denying that Costco is a fantastic business with an incredible moat. It has been relentless in its efforts to pass on cost savings onto its massive consumer base. Consequently, it trades at a premium multiple.
COST stock has been an anomaly during the past couple of years. While its peers have struggled to gain traction in the stock market, COST stock has returned over 64% in the past 12 months. It now trades at around 40x forward earnings, a dumbfounding number. Though its business remains tip-top shape, we must separate it from its stock.
Strong Quarterly Results
It was business as usual for Costco during its fiscal second quarter. It posted another revenue and earnings beat, which is the seventh time it’s done so in the past nine quarters. Net sales improved by roughly $7 billion to $50.94 billion. Moreover, its operating income improved by 35.2% from the same period last year to $1.8 billion. Costco has maintained its consistent track record of generating robust sales and earnings growth.
Additionally, the company’s comparable sales for the quarter increased by 14.4%. The pandemic fade has a lot to do with foot traffic and shopping frequency improvements, which have risen 9.3% globally. During the quarter, Costco opened five new units. It plans to have 32 new ones and four relocations for the full year.
Furthermore, the company’s online business is also proving its worth, as its ecommerce sales rose a spectacular 12.5% from the prior-year period. The company has been criticized for its online sales channels, but its recent performances suggest that it can do some real damage in the sector. Additionally, it ended with a whopping $11.82 billion in cash equivalents with $6.6 billion in debt. That translates into a healthy cash-debt ratio of 1.7. With its growth strategies, superior price control, and sensational membership numbers, it will continue to perform well in the market.
Unjustifiable Valuation
It’s easy to wrap your head around why investors justify a meteoric valuation for Costco. It operates a rock-solid business that has performed consistently over the past several years. However, paying 40x forward earnings for its stock is just too much. Such a premium valuation wouldn’t lead to attractive returns in the future.
One of the key investing principles is that you shouldn’t be overpaying for a business. Costco trades over its intrinsic value. It doesn’t have the lofty growth numbers to support such a valuation. Its long-term earnings growth is well below the sector average.
Moreover, its free cash flow yield on a year-over-year basis is deplorable 0.3% compared to the 7.5% CPI inflation. Though it boasts an impressive dividend growth history, its 0.6% yield is nothing to be excited about either.
Bottom Line On COST Stock
There’s plenty to like about Costco as a company. You can’t argue with its moat and its glittering financials. However, its premium valuation is where you’d probably want to reconsider other options.
It would be fair to say that it’s perhaps the most overvalued mega-cap company in the U.S. currently. It would help if you kept COST stock on your watch list, but it’s best to avoid it at this point.
On the date of publication, Muslim Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.