Costco is an incredibly successful and well run company
Shareholders have seen very high returns as the company builds out e-commerce offerings
The company is valued more as a technology company than a traditional retailer
Share price currently exceeds Wall Street consensus target for 12 months
The market implied outlook, which represents the options market consensus, is slightly bullish through mid-2022, but slightly bearish for the full year
Costco Wholesale (NASDAQ:), the membership warehouse chain with retail outlets around the world, has boomed over the past 12 months, with a total return of 52.9%. The company reported FY on December 9, 2021, surpassing consensus forecast earnings per share by 12.9% according to E-Trade. important transition for physical retailers. With this rapid growth in e-commerce, the market has reevaluated the stock. With the extreme growth potential and economies of scale offered by online selling, the market has become accustomed to much higher stock prices relative to current earnings for COST. Charlie Munger of Berkshire Hathaway predicts that COST will continue to grow as a leader in online retail. In the performance of the company it is difficult to find something that you do not like, the shares have risen to quite extreme valuation levels. COST has a lagging 12-month P/E (TTM) of 47.35, significantly higher than the P/E ratios of Apple (NASDAQ:), Microsoft (NASDAQ:), Alphabet (NASDAQ:) ( NASDAQ:), and Facebook parent Meta Platforms (NASDAQ:).
However, the P/E of Amazon (NASDAQ:) 66.9 is still significantly higher than that of COST. COST is also slightly cheaper relative to revenue than Walmart (NYSE:) (P/E of 48.8).
Price-earnings ratios for COST and large technology companies
Source: Investing.com
Investors should recognize, however, that Costco is not Amazon. Amazon is much broader than just an online retailer. Amazon Web Services (AWS) is a leader in cloud storage and analytics, a major source of growth. Amazon has also created the de facto standard for e-books and manufactures the Kindle devices to read this format.
There is no doubt that COST is a great company, but no company is so good that there is no stock price. too high.
When I analyzed COST in early March 2021, Costco stock had a P/E of 31.9 and the stock was 20% below its 2020 highs. The consensus of Wall Street analysts was bullish, with a expected price increase of 20% over 12 months. The market implied outlook (derived from option prices and detailed below) for COST through early 2021 was neutral, with low volatility.
I gave COST a bullish rating. When I revisited COST in mid-September, 6-½ months later, the stock was up 41%. At that level, Wall Street analysts' 12-month price target was almost exactly the same as the stock's price. In other words, the stock was already priced in the next 12 months of expected growth, although the rating remained bullish. until June 2022. I changed my rating on COST to neutral, largely because of the valuation. The P/E was 41. Since my September analysis, stocks are up another 23.7%.
For those unfamiliar with the market-implied outlook, a brief explanation may motivate the approach. The price of an option on a stock reflects the market's consensus estimate of the probability that the stock price will rise above (call option) or below (put option) (the strike price) between now and when the option expires. By analyzing the prices of put and call options on a series of strikes, all with the same expiration date, it is possible to calculate a probabilistic price prediction that reconciles option prices. These are the market implied outlook and represent the consensus views of option buyers and sellers.
At the end of 2021, I updated the market implied outlook for COST to reflect mid-2022 and early 2023. As in my previous posts, I compare the market implied outlook with the consensus assessment of Wall Street Analysts and the 12-Month Price Target.
Wall Street Consensus Outlook For COST
E-Trade calculates Wall Street's consensus outlook by combining the opinions of 25 ranked analysts who have surveyed the past 90 days of COST ratings and price targets. The consensus rating remains bullish, but the 12-month price target is 0.82% below the current price. Out of 25 analysts, 19 assign a buy recommendation and 6 rate COST as a commit.
Investing.com's version of the Wall Street consensus was calculated based on the opinion of 35 analysts. The consensus rating is bullish and the consensus price target is 4.9% below the current price.
Both consensus forecasts from Wall Street analysts agree, giving the stock a bullish rating but a 12-month price target that is below current levels. This situation usually occurs when the analysts view a company's long-term prospects as favorable, even though its share price has risen to the point where expected growth has been priced in for the entire next year.
I have calculated the market implied outlook for the next 5.7 months (using options expiring on June 17, 2022) and for the next 12.8 months (using options expiring on January 20, 2023 ). I chose these two options expiration dates because they were closest to mid-2022 and the following year, respectively. return, with probability on the vertical axis and return on the horizontal. ]
The market implied outlook for mid-2022 is highly symmetrical, with similar probabilities of positive and negative returns of the same magnitude, although the peak in probability has tilted very slightly to favor negative returns. The annualized volatility calculated on the basis of this distribution is 26.5%.
To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative side of the distribution around the negative axis (see chart below).
Market Implied COST Return Opportunities for a 5.7 Month Period Trade)
This view shows that the probabilities of positive and negative returns of the same magnitude are nearly identical (the solid blue line and solid red lines are almost on top of each other), although there are very slightly increased chances of negative returns of small magnitude (far left of the chart). In my September analysis, I calculated a outlook using the option expiration date of June 17, 2022 and that outlook was very similar to what we see here.
Theory suggests that the market-implied outlook will be negatively biased due to investor risk aversion, so that put option market prices will be higher than expected value. As such, a symmetric market implied outlook (as seen here) is interpreted as slightly bullish. However, this outlook is significantly less optimistic than the 3.9-month COST outlook calculated in September.
of negative returns (the dotted red line is continuously above the solid blue line for a wide range of the most likely results). The annualized volatility, 27.3%, calculated from this breakdown is in line with the mid-year outlook. Taking into account the expected negative bias, I interpret this market-implied outlook as neutral to slightly bearish. distribution rotated on the vertical axis (Source: author's calculations using options quotes from E-Trade) shifted to slightly bearish. Expected volatility is consistent and quite low for both periods.
Summary
Costco is widely admired and shareholders have been well served. At the current high valuation, however, it is difficult to be optimistic. The consensus of Wall Street analysts is bullish, but the consensus price target for 12 months is below the current share price. The market implied outlook for COST through mid-2022 is slightly bullish, but the outlook for early 2023 is slightly bearish. Expected volatility is modest.
Given the valuation, the stock's high price relative to the analyst's price target and the longer-term market implied outlook, I maintain my neutral rating on COST. It shouldn't be surprising to see some gains in the stock price in the near term, given the positive momentum and slight bullish tilt in the market-implied mid-year outlook.
