Last week, Costco Wholesale (NASDAQ:COST) reported that sales continued to rise at an impressive pace in June. In fact, underlying sales trends improved compared to May in all of its markets.
This news helped lift Costco stock to a new all-time high. Shares of the discount warehouse club giant have surpassed $280: up 30% over the past year and up 84% over the past two years.
Costco Wholesale is certainly a great company with a wide moat and a long track record of growth. However, Costco stock now appears to trade at an excessive valuation relative to its growth rate. As a result, investors should probably wait for a better buying opportunity.
Another great month
Net sales rose 7.5% to $14.57 billion at Costco last month. Comparable sales rose 5.4%, or 5.1% on an adjusted basis, which excludes the impact of currency fluctuations, changes in gasoline prices, and new accounting rules implemented for fiscal 2019. This performance beat analysts' expectations. It also represented an improvement over Costco's 4.3% adjusted comp sales gain for the month of May.
Sales trends were relatively consistent across all of Costco's major geographic regions. Adjusted comp sales rose 5.3% in the U.S., 4.3% in Canada, and 5.5% in the rest of the world. Higher traffic was the biggest driver of Costco's sales growth, with comparable-store traffic up 3.7% worldwide, including a 3.4% increase in the domestic market.
Growth was also consistent across all of Costco's broad merchandise categories. That said, the company continues to report particularly strong sales growth for items like toys, apparel, and housewares, for which competitors' store closures have significantly reduced competition over the past year or two.
Management noted that Costco is posting its strong comp sales growth even as it opens new warehouses at a steady pace, cannibalizing sales from existing locations. Cannibalization hurt comp sales growth by about 0.8 percentage points last month, according to the company.
Profit growth is set to slow
After a weak start to the year, Costco reported massive earnings growth for the second quarter of fiscal 2019. Last quarter -- the third quarter of Costco's fiscal year -- earnings growth moderated, with operating income rising 5.2% year over year. Adjusted earnings per share jumped 11%, but some one-time tax items drove a substantial portion of that earnings growth.
Earnings growth is likely to continue at a more moderate pace -- on average, at least -- over the next several years. That's because some of the biggest tailwinds that have driven Costco's earnings growth in recent years are fading.
Most importantly, Costco raised its annual membership fee in the U.S. and Canada by about 9% two years ago. Because of the way the company accounts for membership fees, the extra revenue filters into its financial results over the course of 23 months. That has provided a sizable boost to its earnings growth over the past two years, because membership fees account for the vast majority of Costco's profit. However, Costco only raises its fees every five or six years, so investors will have to do without this earnings tailwind for the next several years.
Costco stock is just too pricey right now
Following its recent rally, Costco stock trades for about 35 times its projected fiscal 2019 earnings per share (EPS) of $8.04. That's nearly double the forward P/E ratio of the broader market.
To be fair, Costco does have more room for long-term sales growth than the average company. Its massive purchasing power -- which allows it to beat rivals' prices consistently -- and strong customer loyalty should enable Costco to grow revenue at a high-single-digit annual rate for many years to come.
That said, analysts expect modest EPS growth of about 6% next year, roughly in line with Costco's projected sales growth of 7%. That's not enough earnings growth to justify the stock's current valuation. There are better opportunities for investors in the market today, and there will probably be better entry points for buying Costco stock in the years ahead.