Costco Is Down 15% From Its High. Time to Buy?

With the widely followed S&P 500 index finishing 2022 down 19%, investors might be scared to put their money to work. But now could be a great time to search for bargain opportunities. 

Investor sentiment might already be well on its way to turning positive, as the stock market is up so far in 2023. Optimistic and long-term focused investors should still be looking to add great companies to their portfolios. If their share prices are under pressure, that means an even better buying opportunity for you. 

Costco Wholesale (COST 1.01%), one such stock to pay attention to, is down about 15% from its all-time high that was set in April last year. Is now the time to buy this top retail stock? Let's take a closer look. 

Costco's resilient business model 

After posting net revenue growth of 17.8% in fiscal 2021 and 16.1% in fiscal 2022 (ended Aug. 28), Costco's business has been dealing with a bit of a slowdown. Sales only increased 8.1% in the most recent fiscal quarter (the first quarter of 2023, ended Nov. 30). And in the month of January, revenue was up just 7.5% versus January 2022. This continues a trend of decelerating growth. 

It's worth mentioning that the latest growth figures from Costco are mostly in line with the company's gains prior to the coronavirus pandemic, and this should ease any investor worries about the business hitting a prolonged rough patch. The health crisis undoubtedly was a boon for Costco, whose 845 warehouses focused on providing shoppers with the lowest prices around. In fact, Costco's value proposition shined as consumers could buy all of their essentials in one trip. 

And even in the face of heightened inflation throughout 2022, Costco's business remained resilient. In fiscal 2022, foot traffic and the average transaction size were up in the U.S. I think this speaks to how wonderful of an enterprise Costco really is, showcasing its all-weather appeal. 

Bolstering Costco's competitive positioning is its incredibly successful membership model. With 66.9 million membership households (as of Nov. 30), this is a high-margin revenue stream for the company. In the latest fiscal year, membership fee revenue increased 9% year over year to $4.2 billion. And with a superb renewal rate worldwide that usually remains north of 90%, Costco has proven to drive increased loyalty from its customer base. 

Investors might look at Costco and quickly assume that because the business is so focused on offering a broad assortment of merchandise at low prices, it has no pricing power. But this would be a flawed assumption. Costco actually does have pricing power when it comes to membership fees. Management last instituted a price hike in June 2017, with seemingly no customer resistance, as proven by the expanding membership base. According to the management team, another membership price increase is on the horizon in 2023. 

Consider the valuation 

Over the past five years, Costco shares have produced an outstanding return of 182%. And this doesn't include the numerous outsize special dividends throughout the years that have helped boost shareholder returns. Even with the stock off 15% from its peak, it still trades at a hefty price-to-earnings (P/E) multiple of 39. This valuation is higher than the 10-year historical average. 

Even though Costco is a great business, I believe that's too expensive. According to Wall Street consensus analyst estimates, Costco is projected to increase revenue and earnings per share at a compound annual rate of 7% and 11.1%, respectively, between fiscal 2022 and fiscal 2027. While these are respectable gains, they still don't justify paying such a steep P/E to buy the stock right now. 

If you're a current shareholder, by no means should you view this as a recommendation to sell your holdings. Costco is a stock you'd want in your portfolio during economic times like today that are drowned in heightened uncertainty. Moreover, the company's durable and sustainable growth is something investors should look for in all the stocks they buy. 

But for investors who are on the sidelines, the best course of action is simply to practice patience. Wait for a better entry price before becoming a buyer of Costco stock.