Big Boxes Are Back, and Costco’s a Winner

An opportunity may be coming to buy Costco Wholesale (NASDAQ:COST) stock. Investors are selling stocks in the biggest retailers, even as they report blowout earnings. If the pattern holds after Costco reports Dec. 9 earnings, you may be able to get some for Christmas.

As trading opened Nov. 19, Costco was the most expensive prize in the sector. At $535 per share, its market capitalization was $236 billion. It was selling at a 15% premium to sales, unheard of for thin-margin retail. Its price to earnings ratio was an eye-popping 47. That’s getting close to Amazon.Com’s (NASDAQ:AMZN) almost 70.

I’ll drive miles out of my way to go to Costco, blowing past a Walmart (NYSE:WMT) Sam’s Club without a glance. But I won’t pay that price for the stock.

Selling the News

There’s hope in the fact that investors are selling the best environment for big box retailers in decades. On Nov. 6, Walmart topped earnings estimates with a net income of $3.11 billion, $1.45 per share, on revenue of $140.5 billion. The market responded by sending the shares down.

The news from Target (NYSE:TGT) was nearly identical. The company smashed earnings estimates at $1.49 billion, $3.04/share, and revenue of $25.65 billion.  The stock sold off.

The excuse given by analysts came in statements from the companies that they would absorb price increases and prioritize market share. Scroogy analysts say investors want the customers gouged, given the limited competition. You’ve got them by the throat, they’re saying, squeeze.

That’s not how the big box rolls. Scaled retailing is about sales volume. As with Amazon, the key metric is operating cash flow. Walmart had $36 billion in operating cash flow in fiscal 2021, which ends in January. Target had $10.5 billion. Walmart is selling at just 11 times its 2021 cash flow number, while Target at just under 12 times.

COST Stock Is Stretched

Based on those metrics, Costco’s valuation is stretched. It had $9 billion in operating cash flow for fiscal 2021, which in this case ends in August. The COST stock is selling for over 25 times that.

But Costco margins are also wafer thin. Until a few years ago, its net income usually matched up with its membership fees but last year was unusual. Net income was 20% higher than the fees — but we’re still talking about just $5 billion in earnings on $195 billion in revenue. Just 2.5% of the money coming in is hitting the net income line.

This doesn’t mean the last person into Costco stock was an idiot. Over the last five years, Costco stock is up 250%. There’s also a dividend, which has climbed from 45 cents to 79 cents per quarter.

I was a fool to sell my own Costco shares a few years ago. Unless you’re a trader, looking for quick dopamine hits of profit, you may not want to sell here, either.

The Bottom Line

Analysts are expecting earnings of $2.59 per share and revenue of $47.5 billion when Costco next reports. If history, and the crowds at my local store, are any indication, it should beat those numbers easily.

Inflation is a boon to stores like Costco. When you buy big quantities, you get the best prices and the gas is cheaper than anywhere else, which is why there are gas lines at Costco in good times and bad.

If there’s a threat to Costco, it’s demographics. Younger consumers can’t afford their parents’ big homes. Many lack their parents’ big SUVs so they shop online and in limited quantities. Their numbers are growing, and their parents are dying off, or we’re downsizing ourselves.

But Costco still has years to adapt to any new retailing rules. Let it drop, then buy it.

On the date of publication, Dana Blankenhorn held a long position in COST. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Dana Blankenhorn has been a financial and technology journalist since 1978. Just in time for the holidays he has a collection of COVID-19 stories at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or tweet him at @danablankenhorn. He writes a Substack newsletter, Facing the Future, which covers technology, markets, and politics.