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Costco: Low-Priced Products, Expensive Stock

Costco: Low-Priced Products, Expensive Stock
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Friday, 07 June 2019 04:39 PM Current | Bio | Archive

Dividend growth stocks can be highly rewarding investments over the long-term. The downside of many dividend growth stocks is that they often have low dividend yields, and high valuations. This can be problematic for value and income investors.

For example, while Costco Wholesale (COST) is one of the top grocery stocks, and recently increased its dividend by 14%, the stock still has a relatively low yield of 1.1%. And, even though Costco is beloved by its customers for its low prices, the stock itself is quite expensive. Investors looking to buy shares of Costco should wait for a meaningful dip before jumping in.

Growth At A Steep Price

Costco is the strongest growth company in the grocery industry right now. Its recently-reported second-quarter earnings prove this, as total sales increased over 7% and rose over 8% in the first half of the fiscal year. Comparable sales were up 7.4% in the U.S., a high growth rate that other companies would love to have.

Costco’s high sales growth is accompanied by membership fee growth. Membership fee revenue also increased above 7% last quarter. Earnings-per-share rose 26% in the second quarter year-over-year, increasing from $1.59 to $2.01.

There is little question Costco is a high-quality growth stock. The only potential problem with buying Costco stock today is its high valuation. Costco’s price-to-earnings multiple has been above the industry average for many years, thanks to its elevated growth rate. But investors today have to pay a relatively steep price.

Today, Costco shares trade for a price-to-earnings ratio of 32x, which is a very high valuation, particularly for a retail stock. Costco shares are as expensive right now as they have been in the past decade, and as a result the stock is overvalued.

The other negative aspect of buying richly-valued stocks is that they often have lower dividend yields. A rising share price has the effect of lowering a stock’s dividend yield, as price and yield move in opposite directions. Costco has helped mitigate this impact by raising its dividend payout at a high rate. Costco has increased its dividend for over 10 years in a row, making it a member of the Dividend Achievers list.

Still, despite a high dividend growth rate, Costco is still unattractive for income investors. With a current yield of 1.1%, Costco stock barely yields more than half the S&P 500 Index average, currently around ~2%.

The overvalued stock price could reduce shareholder returns in the years ahead, if the P/E ratio contracts toward a lower level. Even positive earnings growth and the dividend yield may not be enough to offset the impact of a high valuation.

The Bottom Line

Focusing on buying high-quality businesses is a great step toward generating superior long-term returns. But even a great business can turn out to be a poor investment, if investors pay too high a price for the stock. This seems to apply to Costco today. There is little question that Costco is a growth company, and one of the strongest brands in discount retail. However, the stock is simply overvalued today. Investors should wait for a better buying opportunity before scooping up shares of Costco.

Ben Reynolds is CEO of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth stock portfolios for the long run.
 

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BenReynolds
Dividend growth stocks can be highly rewarding investments over the long-term. The downside of many dividend growth stocks is that they often have low dividend yields, and high valuations. This can be problematic for value and income investors.
costco, low price, products, expensive, stock
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2019-39-07
Friday, 07 June 2019 04:39 PM
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