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Motley Fool Issues Rare “All In” Buy Alert
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Stock market corrections are normal, so investors are searching for safe stocks to buy today. The global economic backdrop is more uncertain than it has been in a long time with generation-high inflation, rising borrowing costs, and a war in Ukraine. The S&P 500 has declined 15% year to date. Some investors believe a bounce back is in sight, while others fear a dreadful recession in the near future.
Either way, Costco Wholesale (COST 0.57%) is battle-tested, and in many ways it has (dare I say) proved to be recession-proof. The membership-only retailer has lived through four recessions since going public in 1985 and is up nearly 60,000% over that time, excluding dividends.
Since the near-term future of the global economy remains a big question mark, should investors pounce on Costco stock today?
Image source: Getty Images.
Costco is a consumer staples stock. By and large, it sells essential goods, so it’s less affected by economic cycles than most other businesses. And it has a secret sauce that makes it all the more consistent: a membership program.
For $60 per year, members can visit any of its warehouses worldwide. That membership fee, combined with its low prices and widely praised shopping experience, keeps customers in its stores. As of its second quarter, the membership renewal rate in the U.S. and Canada was 92.3%.
Its $984 million in membership fees represented 72.7% of its $1.35 billion bottom line in the second quarter, so you can see how the company generates steady net profits. And with memberships steadily growing (up 9.2% year over year in the second quarter), its robust customer retention rate makes Costco consistent over the long run.
It’s unlikely that the retailer will up its membership fees this year amid high inflation, but there should be an increase coming sooner rather than later. The company generally raises its membership fees every five years, and last did so in 2017. When that happens, it should boost the bottom line, all else equal.
In the end, consistency means cash. As of its latest quarter, the company has $11.2 billion in cash and equivalents. It has generated $4.1 billion in free cash flow (FCF) over the past 12 months. Steady net profits and cash-flow generation are ideal traits in a darkening economy like today.
Relative to its own historical valuation and its retail peers, Costco is an expensive stock. Today, it has a price-to-earnings (P/E) multiple of 42, above its five-year mean of 36. And it carries a nosebleed valuation compared to some of its top competitors. BJ’s Wholesale, Walmart, and Target have P/E multiples of about 22, 27, and 20, respectively. But even if you believe the retailer deserves a premium valuation, it’s still trading above its own historical levels.
Next year, Wall Street analysts expect Costco’s top and bottom lines to expand 8.2% and 10.5% year over year, respectively. Those are solid growth rates, but Microsoft is forecast by analysts to grow its top and bottom lines by 13.9% and 17.9% next year, respectively, and the stock has a P/E of just 27. So no matter how you carve it, Costco stock is pricey.
Don’t buy the stock yet. While I love the business, I don’t love the valuation. I’d suggest that investors keep the retailer on their radars. Once it sinks below its historical valuation levels — which could happen at some point — that is when prudent investors should pounce. So, to answer the question in the headline: No, now is not a prime time to buy Costco shares.
Luke Meindl has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale, Microsoft, Target, and Walmart Inc. The Motley Fool has a disclosure policy.
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