If you believe in holding shares for the long term, I’d suggest that you take a closer look at Costco (NASDAQ:COST), the second-largest global retailer by revenue. Costco stock has rewarded its shareholders well in 2019 and we can expect these rewards to continue.
As many analysts debate whether an economic slowdown is around the corner, long-term investors, who may want to recession-proof their portfolio, could regard any dip in the stock price as a viable opportunity to buy into COST shares.
Should Investors Worry About the Invested Yield Curve?
I have been increasingly noticing the economically dreaded “r” word in the media. While analysts are divided as to whether many global economies including the U.S. could be headed toward a recession in the near future, investors could benefit from thinking about how to recession-proof their portfolios.
Are we almost at the tail end of nearly a decade of economic growth? Although there have been a few short-lived downturns over the past 10 years, most economies have enjoyed stable growth since the recession of 2008-09.
However, in March as well as earlier in December 2018, fears of a U.S. recession that could also spread to other countries hit the headlines as analysts highlighted the inverted yield curve in the U.S. This signal occurs when U.S. short-term treasury notes yield more than longer-term instruments. Many analysts warn that an inverted yield curve may be a sign of an upcoming recession.
We will not know when the next recession has exactly started until we are in it, but generally, the economy and investors’ sentiment can change rather quickly. What looks like a bull market today can become a bear market the next month.
Therefore, if you are of the opinion that an economic slump may be almost upon us, you may want to reconsider your portfolio diversification strategies. Certain industries and stocks tend to do better in times of slower economic growth.
Costco’s Business Model Makes It a Resilient Stock
A defensive company usually has a constant demand for its products or services and isn’t typically correlated to the rest of the business cycle. Costco operates in the warehouse club (or wholesale club) space within the retail industry.
Due to the low-cost and high-value products offered by warehouse clubs, this sector usually performs well regardless of macroeconomic conditions. In this segment, Costco’s main competitor is Walmart (NYSE:WMT) and both companies are thriving in this competitive environment.
Costco runs on a “subscription business model,” whereby customers pay an annual membership fee to have access to its bargain-priced bulk goods.
Costco offers three types of membership: Executive, Business and Gold Star. In total, Costco collects over $3.1 billion in membership fee revenue, which is almost entirely profit. The membership service has a renewal rate of 90% as the group scores high on customer satisfaction surveys.
By using a membership-only system, Costco is able to book nearly all of its profits one year in advance. In other words, the annual membership model contributes to its operating income and gives Costco stock immense earnings stability.
Costco sells merchandise at bargain prices, across six main categories:
- Foods (such as dry, packaged and groceries)
- Sundries (such as snacks, beverages and cleaning supplies)
- Hardlines (such as appliances, electronics and health products)
- Fresh Foods (such as meat, produce, deli and bakery)
- Softlines (such as apparel and small appliances)
- Ancillary (such as gas stations and pharmacy)
These ancillary businesses provide a range of products and services that aim to encourage members to visit Costco stores more frequently. Coupled with strong customer loyalty, the retail giant has pricing power, too.
In other words, the membership structure has become a source of much of Costco’s competitive advantage. Price-sensitive members are visiting the store regularly. No matter how the economic climate changes over the years, the retailer is likely to put up steady growth.
COST Stock Has Robust Fundamentals
In 2018, Costco’s comparable sales adjusted for fuel prices and currency rose 7% and total sales reached $138.4 billion. On March 7, the retail giant announced revenues of $35.4 billion, thanks to the growth in membership fees. For fiscal Q2, Costco reported earnings per share of $2.01, 31 cents ahead of expectations.
In 2019, analysts now expect the warehouse chain to earn $7.92 per share, up 11.7% from last year, buoyed by new store openings and strong same-store sales growth. Wall Street is also applauding its low-cost structure, one of the lowest in the retail industry.
Furthermore, the company has a burgeoning e-commerce operation. E-commerce comparable sales (comps) jumped almost 26% year-over-year (YoY). Its online and same-day delivery show strong growth and is likely to add to Costco’s bottom line for years to come.
In short, investors have been approving of the steps, including customer and employee satisfaction, favorable job scene and opening of new warehouses globally, that Costco’s management has been taking over the years — factors that are likely to translate into a strong balance sheet in the rest of the decade.
Asia, including Japan, Korea and Taiwan, is a key market for Costco. The company sees increasing membership signups on the opening day of Asian stores. It is also about to open up its first store in China. The opening of new warehouses in Asia could accelerate the company’s current growth rate.
What Could Derail Costco Stock?
Year-to-date, COST stock is up 21%. So, in the next few weeks, there might be some profit taking in the stock. As a result of the recent impressive run-up in the price, short-term technical indicators have become somewhat over-extended.
Investors who pay attention to short-term oscillators should note that Costco’s technical message has also become “overbought.”
In the next few weeks, COST stock could trade sideways for several weeks, and even have a pullback toward the low-$230’s or even mid-$220’s level, where the stock is likely to find major support. However, if the stock price were to go below $225, there could be further profit taking and the stock could go down to low $200’s.
COST stock’s beta is 0.96, which means its volatility on average mimics that of the broader market. Therefore if the industry or the broader market declines as other companies, especially competitors, release earnings, the Costco stock price may also be adversely affected. In other words, investors should watch for market corrections.
If you already own Costco stock, you might want to hold your position. That said, if you are worried about short-term profit taking, then within the parameters of your portfolio allocation and risk/return profile, you may consider placing a stop loss at about 3-5% below the current price point, to protect your profits to-date.
The Bottom Line on COST Stock
Q2 may bring further volatility to the stock market, and I would not advocate bottom picking; however, I’d regard any price dip in COST stock as a buying opportunity for long-term shareholders. Due to its membership-only system, Costco is a unique warehouse stock with attractive high margins and downside earnings risk. I believe Costco will continue its long track record of strong performance and by the end of 2020, I’d expect the shares to reach $275. Finally, investors who buy into the COST stock price can enjoy a dividend yield of 0.93%.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.
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