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Costco Stock Gets a Downgrade at the Worst Possible Time

Rick Munarriz, The Motley Fool

The class act among warehouse-club operators is hoping to earn a passing grade this week. Costco (NASDAQ: COST) reports its fiscal third-quarter results this week, and there are good reasons to feel bullish. Comps have remained positive in recent months, and the stock hit all-time highs last week ahead of Thursday afternoon's earnings release. 

With optimism percolating, it may have come as a surprise to see one Wall Street pro downgrade the stock on Wednesday, but one can also argue that it's probably the best time to shift into a new direction. Gordon Haskett analyst Chuck Grom is downgrading Costco from accumulate to hold. He argues that this is not a judgment call on the upcoming financial update, but it's hard to take it any other way. Why upgrade or downgrade a stock the day before a pivotal earnings release unless you think the stock will move a certain way following the quarterly report? 

Exterior of a Costco Wholesale store.

Image source: Costco Wholesale.

Stock gains in bulk

Wall Street is holding out for another period of slow-yet-steady growth at Costco. Analysts are targeting a profit of $1.82 a share on $34.67 billion in revenue, growth of 7.1% on both ends of the income statement. Costco provides monthly sales-trends reports, so analysts are usually within a healthy horseshoe throw of nailing the warehouse-club chain's top line. It's a different story on the bottom line where there are far more unknowns for Wall Street pros to calculate. 

Costco has routinely beaten analyst profit targets but has been looking pretty mortal lately. It has topped earnings estimates just once in the past three quarters. 

Gordon Haskett's Grom isn't down on Costco but is making a valuation call here. He's sticking to the same $225 price target he established early last year, and with shares now comfortably ahead of that goal, it would make sense to take a neutral -- if not bearish -- stance if he's not comfortable in moving that finish line higher. He feels that investors should pare back their exposure to Costco given the stock's better than 20% gain so far in 2019. 

Costco is the undisputed darling in its niche but it's not cheap. This will surely be the seventh fiscal year in a row that the warehouse-club operator checks in with single-digit revenue growth, but the stock is trading for more than 30 times trailing earnings. Look out to fiscal 2020, and it's still a stiff profit multiple of 29. 

Grom can be wrong. Costco has always traded at a premium to the market, and rightfully so. It's the warehouse-club chain that has withstood the attack of e-commerce giants and discount department stores with groceries-in-bulk intentions. It can beat the market's achievable expectations for the second quarter in a row and paint an even rosier picture of its near future. A dicey market can also help as investors trade in their high-growth stocks for Costco as an all-weather defensive play. 

It's still important to pay attention to analyst moves just ahead of a critical quarterly report. Grom's downgrade can't be ignored. It's now up to Costco to make him regret the move.

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Rick Munarriz has no position in any of the stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.