At the forefront of the artificial intelligence (AI) revolution, it’s not just tech and internet stocks that have been winning for shareholders. Even companies in old, boring industries can post outstanding gains.
Just look at Costco (NASDAQ: COST). This magnificent retail stock has crushed it for shareholders in the past three years, soaring 98%, a return that includes dividends. Costco is undoubtedly a wonderful company, but you should avoid it like the plague.
Here’s why.
A bright-red flag
Thanks to the stock’s monumental performance, prospective investors have one key reason to hesitate to buy shares. And that’s the steep valuation.
As of this writing, Costco stock trades at a price-to-earnings (P/E) ratio of 46.8. This is 38% higher than its trailing-10-year average. And it represents a 107% premium to the S&P 500.
All else equal, investors always want to prioritize paying an attractive valuation to buy shares in a business. It doesn’t matter how wonderful a company it is. If you acquire shares when the market sells them at a huge markup, forward returns have a higher chance of disappointing you. In other words, it’s more likely the investment will underperform.
I believe that is the case here. If you’re willing to pay that P/E multiple, you’d be getting a business expected to grow earnings per share at a compound annual rate of 10.8% between fiscal 2023 and fiscal 2026. I don’t think that’s worth the hefty price tag.
So many green flags
That one red flag is enough reason for investors to pass on buying the stock right now. But to be clear, Costco is a fantastic company. Therefore, it should be on every investor’s watch list.
Costco has proven to be a very durable business that has stood the test of time. This longevity is a direct result of the company’s scale advantages. Costco generated $238 billion in merchandise sales in fiscal 2023 (ended Sept. 3). This gives it unrivaled purchasing power with its vendors, allowing the business to obtain favorable pricing on goods. And these savings are continuously passed to shoppers through lower prices.
More and more shoppers are turning to Costco. As of Feb. 18, the business had 73.4 million membership households, a figure that increased 7.8% year over year. Selling high-quality items at low prices in massive warehouse clubs is a simple strategy that works.
What’s noteworthy is that Costco has continued to grow its revenue and earnings in the face of the ongoing threat of e-commerce. Even with a competitor like Amazon offering fast and free shipping on millions of items, Costco’s financial performance shows that it’s been unfazed.
In the past five years, net sales and operating income are up 65% and 71%, respectively. The success of these two important metrics has, unsurprisingly, helped drive the stock higher. Looking ahead, Costco will keep posting growth thanks to same-store sales increases, the opening of new warehouses worldwide, and the implementation of the occasional membership fee hike.
This all points to a business that can be correctly labeled as being great. But it’s critical to remember that just because a company falls into this category doesn’t mean you’re staring at a worthwhile investment opportunity. I believe this is the present situation with Costco. Investors, broadly speaking, are fully aware that this is a high-quality enterprise.
As a result, I think it’s best for prospective investors to wait for a more attractive entry valuation.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon and Costco Wholesale. The Motley Fool has a disclosure policy.
1 Magnificent Stock That Has Soared 98% in 3 Years: Here’s Why You Should Avoid It Like the Plague Right Now was originally published by The Motley Fool
