Is Costco Wholesale Corporation’s (NASDAQ:COST) PE Ratio A Signal To Sell For Investors?
Costco Wholesale Corporation (NASDAQ:COST) is trading with a trailing P/E of 29.7x, which is higher than the industry average of 21.4x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Costco Wholesale
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for COST
Price-Earnings Ratio = Price per share ÷ Earnings per share
COST Price-Earnings Ratio = $203.76 ÷ $6.866 = 29.7x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as COST, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 29.7x, COST’s P/E is higher than its industry peers (21.4x). This implies that investors are overvaluing each dollar of COST’s earnings. Therefore, according to this analysis, COST is an over-priced stock.
A few caveats
However, before you rush out to sell your COST shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to COST. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with COST, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing COST to are fairly valued by the market. If this does not hold true, COST’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to COST. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for COST’s future growth? Take a look at our free research report of analyst consensus for COST’s outlook.
Past Track Record: Has COST been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of COST’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
