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3 Reasons to Sell Costco

How do you define a blue chip stock? By most investors' definitions, the company would be a model of consistency. It would also pay a decent dividend and be retiring its shares. If you are investing in a retailer, you might also want to see consistent sales growth and strong comparable store sales. If these define a blue chip stock, it seems like Costco (NASDAQ: COST  ) has lost its way.

A changing industry
The grocery industry is changing fast. New entrants are pushing out some of the established players. Costco is arguably the dominant warehouse chain, but both traditional retailers and existing grocery chains are stepping up their games to try to take as much market share as possible.

Years ago, Costco only had to worry about Wal-Mart's (NYSE: WMT  ) Sam's Club division. Today, Wal-Mart's domestic division gets 55% of its sales from grocery sales. Companies like Kroger (NYSE: KR  ) not only have strong grocery locations, but are also diversified into fuel, jewelry, and convenience stores as well.

Another challenge facing Costco and other companies in the grocery business is the possibility of online sales. Amazon offers delivery through AmazonFresh, and traditional grocers are even getting into the delivery business as well.

The bad news for Costco is that all of this competition is hurting its usually strong sales. You would never know that it's suffering based on the stock's valuation, and those are just a few of the issues facing the company.

The top problem
There might not be a clearer picture of Costco's problem than the company's slowing top-line growth. Even amateur investors look at sales growth figures to decide whether to buy a stock. Looking at Costco's performance over the last four quarters, this doesn't look like a blue chip performance    .

Source: SEC Filings.

With overall sales growth slowing down sequentially in the last year, investors should be very worried. However, you would never know that anything was wrong based on the stock's performance.

Diluting its future value
The second issue facing Costco shareholders is that the company is issuing more shares than it's repurchasing. While this isn't a huge deal when sales growth is high, as we just saw, the company's sales growth has slowed considerably.

If we look at Wal-Mart and Kroger as comparisons, these companies have retired just over 3% and just under 4% of their diluted shares over the last year, respectively. By comparison, Costco actually increased its diluted share count by almost 1% in the last year. Existing shareholders need to be aware that if the company continues to increase its share count, even if sales growth increases in the future, earnings growth may not keep up.

What is going on with the stock price?
Given the fact that overall sales growth is slowing and that the company is diluting shareholders by issuing more shares, you might expect the stock to trade at a cheaper valuation. However, shareholders seem to be ignoring the company's issues.

If we look at Costco's overall value from dividend yield and expected earnings growth, Costco seems to offer worse value relative to a few of its peers. The company's yield is just barely above 1% and analysts expect earnings growth of around 12.5%. If you combine these traits, investors are being offered a combined 13.5% total expected return. However, at current prices, the stock trades at a forward P/E of more than 23. If we include the yield, the company's price-earnings-growth-yield ratio is 1.74.

Relatively speaking, both Wal-Mart and Kroger offer better value. Kroger pays a yield of 1.5% and is expected to grow earnings by about 9%. With a forward P/E ratio of more than 15, this indicates a PEGY of 1.5. Wal-Mart offers an even better value with a 2.5% yield and nearly a 9% expected earnings growth rate. This gives the company's shareholders a PEGY of 1.3.

The bottom line is that Costco's top-line sales growth is slowing, the company is diluting existing shareholders, and the stock's valuation is less attractive than that of several of its peers. Instead of calling this a blue chip stock, if the company continues to have these issues, the only thing investors will feel is blue.

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Read/Post Comments (3) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 31, 2013, at 1:59 PM, SwiperFox wrote:

    All well and good, but I hate Walmart and love Costco. "Your Jedi Earnings Numbers won't work on me!"

  • Report this Comment On October 31, 2013, at 6:35 PM, tarheel1110 wrote:

    You couldn't pay me to shop at Sam's Club much less have to to pay to be able to shop there. I drive over 140 miles every other month to spend $700 to $1000 at Costco. I agree with SwiperFox!

    I've taken a couple of friends to Costco with me and they tell me that on the same items at Costco cost less, plus their selections are higher quality.

    If all you want is cheap,(not inexpensive) fine shop at Walmart, Sam's and Kroger. If you want some quality, shop at Publix and Costco!

  • Report this Comment On November 06, 2013, at 2:05 PM, NowherebutCostco wrote:

    I prefer Costco because they care about bringing value to their members, their narrow profit margin, quality items, liberal return policy on electronics, value and the fact that they care about their employees with benefits that put the evil hillbilly empire to shame.

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Related Tickers

9/30/2016 4:00 PM
COST $152.51 Up +5.02 +3.40%
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WMT $72.12 Up +1.39 +1.97%
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