PEG Ratio – Fountainheadinvesting

Costco (COST) $ 801 HOLD

Costco has a lot of positives:

Stable, steady, sustainable, and predictable revenue growth of about 5% a year. The business model has strong competitive advantages as the entrenched market leader – BJ’s is a distant competitor and I cannot imagine anyone coming in to even remotely rival Costco in the future.
The company has a growing membership base, which is its crown jewel and is expanding its physical locations at a slow but steady pace. They’re very careful and don’t increase more than 30 stores a year.
Costco’s operational metrics translate into higher profits – profits also grow predictably at 8-10% each year, faster than revenues.

The big negative is the valuation

Costco is an exceptional business and therefore always commands a premium. However, currently, it is priced at 49x 2024 EPS.
Trading at a historically high premium over the market,
Historically high PEG – With a growth of 10% the PEG ratio works out to 4.9 (49/10)
Outside of its elevated trading range of 35x earnings.
The best and perhaps the only time to invest in COSTCO is on major declines otherwise the return on investment would be too low, or we could even lose money if the stock drops from here or stays sideways for a while.
Let’s see if there is a drop post-earnings – I’ll update again.

BJ’s had been a decent performer, starting from the $40’s range in 2020, to $65. (A lot of it Covid outperformance)

That’s about 16% per year. Though in the past year, BJ’s has had a negative return of 10%.

Currently it’s priced at 15x earnings with forward estimates of 5-6% in earnings and 4-6% in revenues, so that’s a Price to Earnings Ratio (P/E) of 15, with growth of 5, that’s a PEG ratio (P/E to Growth) of 3, which is high. I normally try not to pay more than 2, unless there is really superior growth. Not likely in this sector.

Contrast that with closest competitor Costco, which has earnings growth of 10 to 11% but at a P/E of 35 and – that’s even more expensive!

That said, Costco is a far superior business, with more stable margins, operating efficiencies and scale, which attracts both high volume sellers and customers. Costco is about 10X BJ’s and both started out around the same time. BJ’s unlikely to take market share from Costco,

Bottom line – If the stock becomes a bargain around $55 I could see it returning around 7-8% a year. On the other hand a company like this doesn’t fall as much in bad times, it’s a low risk stock.