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A Quantitative Breakdown Of Costco Wholesale Corporation (COST): Expect More Upside


A) Introduction

Costco Wholesale Corporation (NASDAQ:COST) has been one of the best performing stocks of the last 5 years, gaining over 150% during that time frame. This is in comparison to a 50% gain for Wal-Mart and a 100% gain for the S&P 500. The chart below shows this comparison:


The key question facing investors at this point is whether there is any upside left in the stock after such a huge run. We aim to address this question by taking a look at what a host of different predictive metrics reveal. We define predictive metrics as any metrics that have been empirically shown to have predictive ability. We’ll provide academic papers proving each metric’s efficacy as we move through the analysis so investors can see the sources for themselves.

B) Valuation Breakdown

We’ll start with an analysis of Costco’s relative valuation versus its industry group (Food & Staples Retailing), sector (Consumer Staples) and the overall market. Relative valuation is critical to look at as “cheap stocks have higher returns than expensive stocks.” We prefer to look at a blend of different metrics, as it leads to better returns over time (as mentioned in Antti Ilmanen’s “Expected Returns“). This breakdown is shown below:


Admittedly, Costco’s valuation is not the most attractive in the market. But in an otherwise expensive market, Costco’s relative valuation is not that bad. The company is no doubt expensive from a book value basis, with its price to book multiple of 6.1x much higher than the industry group (3.9x), sector (3.8x), and overall market (2.6x) averages. But both its sales yield (182%) and earnings yield (3.61%) fall within the industry averages (227% and 4.1%). This seems reasonable given the extent to which Costco has been dominating the competition.

Overall, our value model rates Costco Wholesale as “Slightly Undervalued” relative to the market and expects a very small positive impact on its long term returns (+0.83% ex-ante alpha). This would likely not be the case in other times in history, but given the current elevated levels of US stocks, Costco is actually slightly undervalued relative to the market.

C) Growth & Momentum Breakdown

Next we’ll look at Costco Wholesale’s growth breakdown, specifically focusing on price momentum, EPS growth, and profitability efficiency. Price momentum is particularly important, as the ‘momentum anomaly’ is almost as strong as the edge from the ‘value anomaly’ (see here). EPS growth & profitability also have predictive power to a lesser degree, as initially outlined in James O’Shaughnessy’s seminal book “What Works On Wall Street.” Costco Wholesale’s growth breakdown is shown below:


Costco falls in the top half of the market in every one of the five metrics listed above, which is a great sign for its future returns. While the stock price has recently cooled off, price momentum has been a strong point for Costco. Gaining 12.8% over the last six months, and 32.2% over the last twelve, Costco has crushed the returns of the average stock in the market (3.3% & 7.4%) in the same time period.

While falling behind the industry group average of +19.7%, trailing twelve month net income has still grown strongly (+15.4%) when compared to the average for the market (+6.74%). Profitability has been a strength, with Costco returning 19.3% on equity and 6.86% on assets, both of which are within the top 30% of the entire market. Overall, our model rates Costco as a “Moderate Growth” company and rates it in the 84th percentile in terms of growth & momentum. This indicates there is solid long term upside in the stock (ex-ante growth alpha of 3.3%, holding everything else equal).

D) ‘Smart Money’ Breakdown

Now that we’ve broken down Costco’s valuation, growth, and momentum profile, we’ll look at how the “smart money” is playing the stock. To do this, we’ll analyze the level of short interest, institutional transactions, and net company insider buying. Historical testing has shown all three metrics to be good predictors of subsequent future returns (see here and here). Costco’s “smart money” breakdown is shown below:

As we can see from the table above, the ‘smart money’ is mostly neutral to bullish on the stock. Company insiders have been selling stock, but nothing serious relative to the averages for its industry group. We have noticed recently that company insiders have been selling their company’s stock across the market, which is a worrying sign given their solid track record of prediction. Insiders know their company better than anybody else, so it’s generally a bad sign when they are all selling at the same time.

Institutions have mostly maintained their positions in the stock, while short interest remains a paltry 1.19% of total float. This is a great sign as it means that the market’s most pessimistic investors don’t see any downside in the company. This level of short interest is about a quarter of the average in its industry group (4.6%), and about a third of the market’s average (3.34%). Overall, there is nothing within the activity of the ‘smart money’ that indicates a bearish sentiment, at least from a relative basis.

E) Conclusions & Summary

Now that we’ve analyzed the numbers, we’ll list and analyze a bunch of different qualitative catalysts that could help propel the company forward in the future.

i) New $4 billion share buyback plan:

We feel this is the most important, as it provides two huge benefits to shareholders. First, buybacks provide a source of stock buying pressure, so investors know that any drastic moves against the stock price will most likely be mitigated by company buying. Second, the $4 billion buyback represents about 6.6% of the current market cap ($64 billion), meaning earnings per share is essentially guaranteed to increase by a solid amount. It also shows that Costco’s management continues to have investor’s best interest at heart. Lastly, there is empirical evidence that strong buybacks lead to abnormally strong future returns.

ii) Recent deal with Visa and Citi:

A great, recent Seeking Alpha article by Dallas Salazar explains this new deal in much greater detail. Essentially, this deal means that Costco will pay very low costs on all credit card purchases moving forward. This should lead to increased margins down the road, and potentially upward analyst revisions.

iii) Low store count + high member retention rate:

Costco drives its profits from membership fees rather than from retail volume, which has resulted in an unusually low store count for a company of its size. Currently, they have 474 warehouses across the US while Wal-Mart has 4,540. Clearly, there is room to grow in the United States, at least from a store count basis. Retention rates currently sit around 90%, meaning that the company is in little danger of membership churn

Other catalysts to consider are the companies continued international expansion, such as their recent partnership with Alibaba’s Tmall, and the companies strong growth in online sales (23% YoY last quarter).

With a valuation that isn’t that expensive when compared to the market averages, Costco combines a solid growth and profitability profile with strong price momentum and a number of future catalysts. The ‘smart money’ remains mostly neutral to bullish on the company’s future prospects. Lastly, the company is extremely shareholder friendly and has a five year history of delivering returns to its investors. We are confident that Costco Wholesale Corporation has more long term upside to come, and remain bullish on the stock.