Valuation Analysis – 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.

Alibaba (BABA) $74, JD.com (JD) $24

At $74, Alibaba does seem like it’s at a rock bottom valuation with 7-8% earnings growth priced at only 8.5x earnings and sales growth of 7% priced at only 1.3x sales. Similarly, at $24, JD is even cheaper at 8x earnings for a 12% grower and 0.3x sales for a 4-5% grower, which is also below its historical average.

But, I suspect given the China risks in the future, low multiples are par for the course. For many, China’s authoritarian impulses such as Jack Ma’s treatment, clampdowns on businesses, on Hong Kong, during the pandemic to name a few, plus supply chain problems, are a strict no-no for further investments. Ironically, a real Chinese wall for investors.

Perhaps low multiples are the new normal for China, so not sure what yardstick or benchmarks to use – or what is the level of discount needed for country/political risk? The deflationary spiral, and decrease in demand is real and not transitory, with no easy fixes – extorting businesses and investors to invest or banks to lend never has good endings, and I’m not saying that with just a philosophical bias. I also cannot see government policies easing, either.

That said, both these businesses are doing all right and will continue to recover over time – I can’t figure out whether investors will re-enter or will give Chinese companies a better valuation. I don’t have any Chinese stocks, so can’t opine – that country/political risk call you’ll have to take.