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Don't Stock Up on Costco

It's a great company, but the stock is not a good purchase right now.
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It is critical to understand the difference between a good company and a good stock. Warehouse sales specialist Costco (COST) is much loved for both its social stances and for its relatively steady history of growth.

Fiscal year 2015 (ends Aug. 30, 2015) earnings expectations of $5.16 per share would register about double the $2.57 figure from the Great Recesssion low in fiscal 2009. The current dividend rate has also risen by around 100% since then.

So, why do I think Costco is a bad buy right now? During the last six months, the shares surged to their highest valuation in more than a dozen years. That puts COST at 27.5x this year's estimate and EPS projections at almost 25x for the fiscal year ending in August of 2016.

COST 6-month

Source: BigCharts.com

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History tells us that the unusually high P/E is unlikley to be sustainable. Costco's 10-year median multiple has been 22.0x. Its 2008 -09 level, at 22.1x, was just marginally higher despite record low, ZIRP-induced interest rates.

Investors who plunged into COST at the top in May of 2000, paid as high as $54.06 per share. Seven years later, in May of 2007, COST was available as low as $53.00. Very patient buy-and-hold types eventually made money but that period represented a huge lost opportunity cost.

Overvaluation is the great equalizer. The chart below shows more recent purchasers, at Costco's 2008 peak P/E of 26x, had to wait three years to get even.

COST 2008-2014

Source: Value Line

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Very good profits came to those who bought in at lower than typical P/Es and with higher than normal yields. Neither of those conditions exist today.

Fight the urge to own "what's working" when the numbers tell you a stock is overpriced. A regression to a more average valuation points to risk of a drop back to $120-$130 -- even if things go as well as expected. Any disappointment might lead to worse than that.

COST Morningstar Rating

Source: Morningstar

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Standard & Poor's gives COST a hard to figure, four-star Buy rating. They call fair value as $123.30, even while noting that Costco's current price is among their worst relative bargains. S&P gave no justification for owning COST now while making the case for a 13% pullback.

COST Standard and Poor's rating

Standard and Poor's

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If you hold Costco, consider taking profits while it's hot. If you were thinking about establishing a position, wait for a more reasonable entry point. COST traded below $110 not that long ago.

At the time of publication, Price had no positions in the stocks mentioned.