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Costco Wholesale Corporation Looks As Strong As Ever -- Time To Buy?

By Bradley Seth McNew - Feb 18, 2016 at 12:12PM

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Costco is firing on all cylinders. After the recent drop, Costco stock looks even more valuable.

Shares of Costco Wholesale (COST 1.59%) are down slightly over the last 12 months following a volatile year and a roughly 9% drop since the beginning of 2016. Is this reason to be concerned about the company's long-term value? Not in my opinion. Here's why you shouldn't let the recent stock price volatility discourage you -- and why Costco stock looks as strong as ever. 

Why it's been a tough year
Costco stock has dropped 8% from mid-December to mid-February, mirroring the performance of the S&P 500. But it's not just in the last two months that have investors worried about Costco's growth potential, as the past year has been wrought with declining gas prices and weak international sales comps.

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Costco has been selling fuel for more than 20 years. The low prices it could offer on gas helped to draw more members, while providing another revenue stream. Now as oil prices continue to get hammered, Costco has taken the same hit in this segment that most other fuel-centric businesses have. 

Then there's the strengthening U.S. dollar, which continues to be a burden on Costco's international sales. Costco has about 1/3 of its nearly 700 locations outside of the U.S. International traffic and sales are actually growing at a healthy pace, but it's not helping Costco's bottom line as much as it normally would because of the declining value of those foreign sales once they're converted into U.S dollars. 

Why the stock looks valuable now
Now that the stock price has dropped, Costco's P/E ratio is 27.7, relatively low compared to the 31-plus ratio that its stock has traded at in recent months. Costco's estimated Aug. 2017 earnings put the current price at just 24 times earnings. This is high compared to Wal-Mart, which trades for around 15 times earnings, but it's nevertheless in line with the industry average P/E ratio of 25 -- which, given Costco's growth potential, makes its shares seem like a bargain. 

Costco's dividend is another bright spot for long-term value seekers. Even though its stock yields only 1%, Costco has been increasing its dividend steadily in recent years, as it did again last month. Its payout ratio is still low, less than 30%. With a clear recent history of increasing its dividend, this low payout ratio signals plenty of room left to increase that dividend further in coming years. 

Costco's long term growth prospects
Other than the stock's attractive valuation, the company is also in a great position for sustained long term growth in three ways:

Photo: Elvis Fool/Flickr

1. Subscription revenue growth

Costco has raised its membership fees slowly over the last 20 years, only increasing it every few years. It's been nearly five years since Costco last raised its membership fees, and it's due for an increase. With more than 81 million members, even a small membership fee increase will provide a substantial earnings boost. 

2. Domestic location growth

Costco opened seven new U.S. locations in the first quarter 2016 ended Nov. 22. The company plans to open 32 new locations total in fiscal year 2016, and 22 of those are planned to be in the U.S. Excluding the effects of gas prices, Costco's domestic comps would have been up 6% in fiscal 2015. While you can't ignore gas prices, this shows that Costco's domestic stores are performing well. It also suggests that, as gas prices stabilize or start to climb again, Costco should be able to report great domestic sales compared to the current year.   

3. International growth

Costco has 10 new stores planned for international locations in 2016, a few already opened in Q1. Costco is cautiously increasing its foot print in its proven international markets like South Korea, Australia, and Japan, while also testing new locations in places like Spain. One benefit of the strong U.S. dollar is that Costco's investment in these foreign markets also looks less expensive and should provide even better ROI in coming years than in the last few. 

Is it time to buy Costco?
Costco stock looked relatively expensive at its peak late last year of $167, about 31 times earnings. Now the market has given investors a small discount on this valuable stock with plenty of long term potential as discussed above. Still, concerns remain over the economy as a whole, including gas prices and foreign exchange rates, meaning that shares of Costco could be further discounted. So should you try to wait and time the bottom of this market to buy in?

It's much more difficult to try to time the market than it is to find high-performing companies with long-term value. With the current share price discount, all of the growth drivers listed above, as well as the likelihood that macro factors impacting the business will eventually even out -- this looks like a great entry point for long-term investors to pick up shares of Costco.

Bradley Seth McNew has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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