A) Introduction
Costco Wholesale Corporation (NASDAQ:COST) has been one of the best performing stocks of the last 5 years, gaining over 150% during that timeframe. This is in comparison to a 50% gain for Wal-Mart (NYSE:WMT) and a 100% gain for the S&P 500. The chart below shows this comparison:
The key question facing investors at this point is whether there is any upside left in the stock after such a huge run. We aim to address this question by taking a look at what a host of different predictive metrics reveal. We define predictive metrics as any metrics that have been empirically shown to have predictive ability. We’ll provide academic papers proving each metric’s efficacy as we move through the analysis so investors can see the sources for themselves.
B) Valuation Breakdown
We’ll start with an analysis of Costco’s relative valuation versus its industry group (Food & Staples Retailing), sector (Consumer Staples) and the overall market. Relative valuation is critical to look at as “cheap stocks have higher returns than expensive stocks.” We prefer to look at a blend of different metrics, as it leads to better returns over time (as mentioned in Antti Ilmanen’s “Expected Returns”). This breakdown is shown below:
Source
Admittedly, Costco’s valuation is not the most attractive in the market. But in an otherwise expensive market, Costco’s relative valuation is not that bad. The company is no doubt expensive from a book value basis, with its price to book multiple of 6.1x much higher than the industry group (3.9x), sector (3.8x), and overall market (2.6x) averages. But both its sales yield (182%) and earnings yield (3.61%) fall within the industry averages (227% and 4.1%). This seems reasonable given the extent to which Costco has been dominating the competition.
Overall, our value model rates Costco Wholesale as “Slightly Undervalued” relative to the market and expects a very small positive impact on its long term returns (+0.83% ex-ante alpha). This would likely not be the case in other times in history, but given the current elevated levels of US stocks, Costco is actually slightly undervalued relative to the market.
