Stock market sale: Is Costco Wholesale a buy?

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Over the past year, many stocks have slumped as inflation, rising interest rates and other macroeconomic headwinds chased away the bulls. However, many blue-chip defensive stocks — especially those whose companies are recession-proof — survived this selloff.

One of these survivors was Wholesale Costco (COST -1.40%), which typically attracts a steady stream of buyers during economic downturns. Customers often buy their products in bulk to save money during tough times, and Costco locks them in with its annual subscriptions. Costco also sells gas cheaper than many stand-alone stations.

Image source: Getty Images.

Therefore, Costco seems like the right stock to buy if you’re preparing for a painful recession. That’s why its shares are up 6% in the past 12 months while the S&P 500 is down 16%. But is Costco really an ideal bear market buy?

Costco Highlights

Costco is better protected against inflation than many other brick-and-mortar retailers because it generates most of its profits from membership fees instead of merchandise sales. This business model allows him to subsidize his sales of low-margin products with his higher-margin membership fees.

Its bulk product sales and the size of its warehouse stores also allow it to operate more efficiently than smaller retailers. This combination of sticky memberships and scale keeps Costco from being disrupted by e-commerce giants like Amazon (AMZN -1.57%)large areas like walmart (WMT -1.93%)and traditional supermarkets.

While many brick-and-mortar retailers have withered throughout the retail apocalypse, Costco’s warehouse count has shrunk from 573 at the end of fiscal 2010 (which ended in August 2010). calendar year) to 838 at the end of fiscal 2022. Its annual revenue grew from $76.3 billion to $222.7 billion during this period, representing a growth rate annual compound (CAGR) of 9.3% over 12 years, while its net income grew at a CAGR of 13.3%.

Over those 12 years, the total number of Costco cardholders more than doubled, from 58 million to nearly 119 million. It also closed the fourth quarter of 2022 with an impressive global renewal rate of 90.4%. In the United States and Canada, which house more than 80% of its warehouses, this rate rose to 92.6%.

As for inflation or a possible recession, Costco management thinks it can offset that pressure by raising its membership fees, which it does regularly every five to six years. Based on this model, it could increase its fees again next year. This pricing power makes Costco comparable to Amazon, which also locks in its shoppers with its sticky Prime subscriptions.

Costco’s Biggest Weakness

Costco’s main weakness is its valuation. Analysts currently expect its revenue and earnings to grow 8% and 11%, respectively, in fiscal 2023. Based on those expectations, it trades at 32 times forward earnings, which which is arguably too expensive relative to its growth rates and those of its industry. peers.

For example, the sportswear retailer lululemon (LULU -6.88%) is expected to increase revenue and earnings by approximately 27% this year. Yet this high-growth retail stock only trades at 30 times forward earnings.

Walmart, which competes with Costco with its Sam’s Club warehouse stores, is growing at a slower pace but trading at just 22 times forward earnings. Costco’s smallest competing warehouse Wholesale BJ’s (BJ -2.23%)which is expected to deliver double-digit sales and earnings growth this year, has an even lower forward multiple of 21.

Therefore, the flight to safety in this bear market has arguably inflated Costco’s valuations to unattractive levels. Five years ago, Costco shares traded at just $164 per share, or 23 times the diluted EPS it would generate in fiscal 2017.

To trade again at 23 times forward earnings, Costco stock would need to fall about 30% from current levels. That could happen if macro headwinds ease and investors turn back to riskier growth stocks.

Is Costco a good buy in the bear market?

Costco is a good long-term investment, but it’s too late to buy the stock as a defensive play in the bear market. Too many investors have already flocked to the stock during the pandemic and subsequent spike in inflation, and it is now historically overvalued. Its low forward yield of 0.8% also won’t provide much downside protection when interest rates rise.

For now, investors should stick to cheaper stocks until the macro picture improves. When that finally happens, Costco shares could ironically drop — and present a much better buying opportunity — as other battered stocks rebound.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Leo Sun holds positions at Amazon. The Motley Fool has posts and endorses Amazon, Costco Wholesale, Lululemon Athletica, and Walmart Inc. The Motley Fool has a Disclosure Policy.

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