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Costco Stock Looks Dicey Now, but Solid Over the Long Term

Vince Martin

Costco Wholesale (NASDAQ:COST) is back where it was in more ways than one. The Costco stock price has reached new all-time highs of late, eclipsing levels reached last September. And once again, COST stock, as impressive as it has been, looks like it might be getting too expensive.

Costco Stock May Be the Market’s Top Recession Pick

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It’s a replay of where COST sat last September. As I wrote at the time, just a few sessions after those all-time highs, analysts had turned cautious on Costco stock. The earnings multiples driving the Costco price were at decade-long peaks just two weeks ahead of earnings.

Those earnings would be solid, but COST stock sold off anyway. By mid-December, amid a market rout, it had lost a quarter of its value.

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It seems unlikely that history will repeat to that extent, barring another market-wide sell-off. But COST does seem to be in a precarious position with earnings on the way next week. The reaction to the report seems likely to focus on one key metric, and the Costco stock price already is assuming quite a bit of success.

Here We Go Again

There’s little question that Costco’s business is one of the best in all of American industry. It’s one of the few companies seemingly immune to Amazon.com (NASDAQ:AMZN), as I wrote last year. Sales growth continues to be impressive: Costco already has reported comparable sales, which included 5.4% growth in April and 6.6% through 35 weeks YTD.

The question comes down to valuation. Certainly, investors so far have been rewarded for paying up for COST stock, which has tripled over the past seven years or so. But even by past standards, Costco stock is expensive, trading at 29x next year’s EPS. Even historically bullish analysts haven’t been able to keep up: the average target price of $250 is just a dollar above Monday’s close.

Again, this is pretty much exactly where COST stock sat eight months ago. And it didn’t turn out well. Will this time be different?

Margins and COST Stock

What will determine the answer to that question likely will be one metric: margins. Again, Costco already has disclosed same-store sales growth, so there will be little in the way of surprises on the top line. As such, it’s the earnings number on which investors will focus.

And margins have been a bit volatile of late. Costco beat EPS expectations by a whopping 31 cents with its Q2 report, which led COST stock higher the next day and for several weeks after. But the stock tumbled after a modest Q1 miss with analysts focusing intently on margins on the post-earnings conference call.

In the current environment, that focus may only heighten. Rival Walmart (NYSE:WMT) is raising prices because of tariffs. Will Costco have to do the same? Will it be able to do the same? Or does its hyper-efficient model mean that tariff troubles at Walmart, pricing pressure at Kroger (NYSE:KR), and spending concerns at Target (NYSE:TGT) all will work to the company’s advantage?

Watching Costco Stock After Earnings

To be sure, it’s exceedingly unlikely that the report is going to lead to a major move in Costco. Options markets at the moment price in just a 4% move between now and next Friday. Again, this is a wonderful business, and the argument will come down to valuation.

But in this market, at least from a short-term standpoint, Costco does look a bit dicey. There’s going to be some disruption to the company from tariffs. Walmart posted a blowout quarter and yet trades modestly below pre-earnings levels. And at nearly 30x next year’s earnings, valuation may be at or near a ceiling.

Longer-term, admittedly, investors still can’t go wrong with Costco stock. But for even the best stocks, valuation matters. COST itself proved that back in September. And while history may not repeat, investors should remember that even a very strong quarter looks priced in.

As of this writing, Vince Martin has no positions in any securities mentioned.

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