Based on a cursory reading of the major headlines, recession fears might not seem immediately evident. However, for those investors that are concerned – and there are reasons to at least consider the prospect – Costco (NASDAQ:COST) offers an enticing idea. No, it’s not the most exciting investment available. However, its predictability and resilience should shine brightly. Therefore, I am bullish on COST stock.
COST Stock Stands Prepared for Whatever Happens Next
Last week, the equities sector ended on a positive note, in large part because of the robust September jobs report. As TipRanks contributor Yulia Vaiman discussed, the nuances present a somewhat optimistic picture. Yes, the jobs report came in unexpectedly hotter. However, wage growth also slowed significantly, which means the Federal Reserve may yet achieve its desired soft landing (slowing down inflation while not entering a recession).
For COST stock, the underlying business is arguably prepared for either outcome. When considering the average Costco demographic compared to the core demographics of other big-box retailers, the former shoppers tend to be younger and make more money. By logical deduction, the Costco shopper is likelier to be better educated, enabling more upward mobility.
Therefore, if the Fed is unable to curb inflation for whatever reason – due to the sheer number of additional dollars chasing after fewer goods – that should have less impact on the educated, upper-middle-class segment that Costco caters to. On the flip side, if the central bank kills inflation but also hurts the economy in the process, the most valuable workers will be the last to be cut.
And if, by chance, policymakers facilitate a soft landing, well, that should be universally positive for U.S. households. No matter what, COST stock appears well-positioned for whatever happens next.
Trusting the Rally for the Long Haul
While the broader fundamentals appear quite encouraging for COST stock, it’s difficult to ignore a key objection: shares have gone up so much. Of course, a year-to-date performance of 24% isn’t exactly the most groundbreaking print ever. However, for a retail giant like Costco, it’s indeed an impressive rally. Unfortunately, that may also mean higher risks of holding the bag.
Adding to the jitters, COST stock slipped by a bit over 1% last week. Obviously, that’s not a great comparison when the benchmark S&P 500 (SPX) popped higher (albeit slightly) during the same period. Nonetheless, while it’s impossible to predict the day-to-day rumblings of COST stock, one can reasonably trust the long-term picture.
Specifically, Costco benefits from profit margin growth. In its most recent quarter ended August, the retailer printed revenue of $78.9 billion, up 9.5% from the $72.1 billion posted in the year-ago quarter. Notably, its gross profit clocked in at $9.7 billion, translating to a gross profit margin of 12.3%, up 50 basis points from one year ago.
Also, its operating margin improved to 3.52% from 3.46% a year earlier. This metric translated to a net income margin of 2.74% in the most recent quarter versus 2.59% in the year-ago period. Most importantly, the discussion about margins is extremely relevant at this juncture.
Primarily, some of the traditional discount dollar stores have failed to impress Wall Street despite the power of their discount-oriented business models amid rising consumer pressures. Notably, Dollar General (NYSE:DG) suffered dearly because it sacrificed gross margins for increased sales. The same can be said about Dollar Tree (NASDAQ:DLTR).
Historically, discount retailers have performed well during economic downturns. However, such companies can’t afford to slash their prices down to the bone. Fortunately, Costco basically has the opposite situation working in its favor.
Not the Cheapest, but One of the Most Reliable
To be fair, another criticism launched against COST stock stems from its valuation. Priced at over 39x trailing earnings, Costco appears overpriced relative to the underlying retail sector, whose P/E ratio is in the teens. Now, it’s difficult to classify Costco, but no matter what, a 39x multiple sticks out in a not-so-pleasant way.
Nevertheless, it’s important to consider why COST stock commands such a rich premium: people continue to shop there irrespective of outside pressures. In other words, Costco has tremendous pricing power. Ahead of an uncertain economic environment, this attribute may be more important than a low valuation on paper.
Is COST Stock a Buy, According to Analysts?
Turning to Wall Street, COST stock has a Strong Buy consensus rating based on 19 Buys, six Holds, and zero Sell ratings. The average COST stock price target is $601.20, implying 7% upside potential.
The Takeaway: COST Stock Isn’t Exciting but Predictable
Quite clearly, no one mistakes COST stock as an exciting venture. That’s not the point of Costco, especially under present circumstances. With ambiguity as to the direction of the economy, Costco brings predictability to the table. Arguably, that’s well worth the premium COST stock carries.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
