Costco - bargain or a trap?

7:10 PM May 20, 2022

Costco is an American wholesaler whose stock price fell sharply this week. What was the reason for such a deep sell-off?

  • Nearly $ 40bn floated out of Costco's stock in just two trading sessions;

  • In the past, the company's shares were characterized by low volatility, and even in the face of turmoil in the financial markets, the price fell less than the competition. Stock lost less than 20% during the Covid crash, and nearly 40.0% during the 2008 crisis. In both cases, the price quickly resumed upward move. Currently Costco is trading over 30% below its mid-April price high;

  • Concerns regarding the recession and changes in consumer spending habits weigh on sentiment around stocks like Costco and Walmart.

Rumors punctured the balloon ?

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Costco stock has experienced one of the largest capital outflows in its history due to concerns over consumer spending, the deteriorating condition of the retail sector and speculation around rate hikes.  The markets were hit by false information regarding higher prices of the 'iconic' duo offered in Costco's food service area i.e. hot dog and soda, which have been priced consistently at $1.5 since the 1980s.  News of the increase to $2.5 has been debunked.

The untrue information fell on exceptionally 'fertile ground', as investors have been panicking for several weeks about recession and economic contraction. Additionally, shares of another popular retailer, WalMart, also lost ground as the company reported quarterly results below expectations, thus weakening the sentiment around Costco. 

It is worth mentioning that Costco shares were traded at a high premium, before recent sell-off the P/E ratio was 35, more than twice as high as the S&P500 index average, which could potentially indicate that the company is overvalued. On the other hand, the high valuation could be related to the recognizable brand that the company has built and the high-quality business model it has developed over decades of operation.

Strong fundamentals

A hot meal for $1.5 and record-low fuel prices at Costco stations are among the strategic efforts to attract customers who are eager to shop in bulk with a paid membership card. Costco for decades has been trying to provide Americans with items and products at the lowest possible prices, even at the expense of margins like the hot-dog mentioned above.

Over the past 30 years, Costco's  stock performance was solid and volatility has remained limited. The high quality of the company's operations and its repeatable and predictable business model have attracted fundamental investors such as the Berkshire Hathaway fund. Charlie Munger, who along with Warren Buffett has run the fund for many years, is known as one of the biggest enthusiasts of the Costco business model.

Temporary fluctuations or broader trend?

Retailers are vulnerable to weaker financial health and lower consumer spending. Inflation can reduce consumer spending, leading to shrinking revenues and net profits for companies from this sector. It is worth noting, however, that in the summer season some shoppers are shifting their focus from goods to services and travel, which lead to weaker performance of chains such as Costco. 

At the same time, it is worth keeping in mind that the economic slowdowns caused by inflation and politics have so far been temporary and have not determined the margins of businesses in the long term, therefore companies such as Costco or Walmart may still be interesting pick for long-term investors. 

Costco will report its quarterly earnings on May 26.

Costco (COST.US) stock fell over 30.0% from its all-time high at $611.20. During today’s session price broke below major support at $425.30 which coincides with 61.8% Fibonacci retracement of the bullish move launched in April 2021. Source: xStation5

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