Is Costco Wholesale Really Worth the Share Price?

It looks as if North America’s favorite club store, Costco Wholesale (NASDAQ: COST), is enjoying a turnaround, but is it really worth $152.71 a share? That’s what the warehouse operator was trading at on March 11, 2016, two weeks after it brought out a stellar earnings report.

Costco’s revenues grew by $1.63 billion in 2017, rising from $115.64 billion in February 2015 to $117.27 billion a year later. The latest earning report indicates that Costco’s revenue increased during every quarter in 2015. That was far better than Walmart Stores Inc. (NYSE: WMT), which saws its revenues fall by $3.52 billion during 2015, and Target (NYSE: TGT), which experienced a slight revenue drop during the fourth quarter.

It looks as if Costco has been able to fend off the challenge from Amazon.com (NASDAQ: AMZN) and weather the storm of growing income inequality and stagnant salaries plaguing Middle America. Even the talk of a Canadian recession does not seem to have slowed it down.

Costco Owns Canada

Costco’s sales in Canada have increased by 10% over the past six months and have grown by at least 7% six quarters straight since September 2014, Silver Times reported. Interestingly enough, analysts think that Canada’s dismal economic climate is driving Costco’s growth. Analyst JoAnne Labrecque of HEC Montreal noted that consumer disposable income in Canada, like in the United States, has not increased in years.

Canada is important to Costco because it gets around 10% of its revenue north of the border. The club store giant has 10 million Canadian members in a nation of 35 million, meaning that nearly one in three of the country’s citizens carries a Costco card. There are actually twice as many Costco stores per capita in Canada than in the U.S.

The factors driving Costco’s success in Canada also push it forward at home in the United States as well. The median U.S. household income has stagnated in recent years. According to U.S. Census Bureau data, it was $53,657 in 2014, just a few hundred dollars higher than $53,105 in 2013 and $52,970 in 2012. That gives most Americans, like most Canadians, a strong incentive to shop at deep discounters such as Costco.

Is Costco a Good Investment?

Okay, so Costco has a really great business model that seems to be perfectly suited with the times, but is it a good investment? Is this club store operator really worth $152.71 a share?

The answer is no because despite some really good numbers, Costco is overvalued. It is a very lousy dividend stock, for example, with a dividend yield of 1.05%; with a $152.71 share price, investors got around $1.60 a share. Spending $152.71 to make $1.60 seems like a lousy deal to me.

Although, Costco does seem to be a pretty good growth play; investors did receive a 21.68% return on equity. Unfortunately, that seems to come from share growth and not the actual business. The business is very good, but I see nothing there worth $152.71 a share.

Why Costco Is Not Worth $152.71 a Share

In particular, Costco does not have the cash or float to justify that kind of share price. It reported a net income of $2.309 billion, a free cash flow of $167 million, $3.895 billion in cash from operations and $4.855 billion in cash and short-term investments on February 29, 2016. That’s impressive for a retailer, but it hardly justifies the share price.

There was something that bothered me in Costco’s earnings though. Its cash and short-term investments dropped significantly. In February 2015 Costco had $7.453 billion in the bank, that dropped $4.855 billion a year later. That’s a decline of $2.598 billion which indicates that Costco is losing some of its float, which is bad for a value investment.

Much of the interest value investors have shown in Costco is in its ability to generate float through memberships. I have to wonder if that business model is less effective, particularly with Amazon offering its own membership club through Prime.

Cheaper and Better Retailers Than Costco

This indicates that Costco is not worth $152.71 a share, particularly with other really good retailers that are much cheaper out there. My favorite, Kroger (NYSE: KR), reported a TTM revenue of $109.83 billion on January 31, 2015, a $1.27 billion increase from 2014, when it reported a number of $108.47 billion. Yet Kroger was trading at $38.64 a share on March 11.

Kroger’s most recent quarterly income of $2.039 billion was nearly that of Costco’s, and its free cash flow of $263 million was actually higher. More importantly for investors, Kroger reported a dividend yield of 1.05%—the same as Costco—and a higher return on equity at 34.06%.

This would indicate that Kroger is a much better bargain than Costco. Kroger is also a deep discounter that sells groceries at prices that are 3% to 5%, and its footprint in the U.S. is growing through strategic acquisition and expansion. Kroger successfully competes directly and successfully with both Costco and Walmart in groceries, fuel sales and pharmacies. In recent years the grocery giant has been branching out into areas such as furniture, dry goods, clothing, hardware and even jewelry.

Nor is it just Kroger. I can think of several cheaper, interesting retail stocks, including Whole Foods Market (NASDAQ: WFM), Sprouts Farmers Market (NASDAQ: SFM), Walmart and Target to name a few. Walmart in particular looks really cheap right now; it was trading at $67.17 a share on March 11, 2016.

What We Can Learn from Costco

The most important lesson that investors can learn from Costco is that a great company can be a lousy investment, especially if it is overpriced. Amazon is also a great company, but it’s a terrible investment because it is grossly overpriced.

My advice for Costco lovers is to wait until the share price falls back to Earth to buy. Do not let your love of a great retail brand dictate how you invest. Instead, wait until it is realistically priced to buy.

Disclosure: Please note that the writer and blogger owns shares of Kroger.