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SUMMARY
Parkev Tatevosian, CFA, provides an in-depth analysis of Costco's recent stock price decline and evaluates whether the current valuation presents a buying opportunity. Despite Costco's strong fundamentals and growth prospects, Tatevosian concludes that the stock remains overvalued relative to its intrinsic value.
MAIN POINTS
- Costco shares have dropped from $1,100 to below $946 following a lackluster quarterly report.
- Record gasoline sales have attracted more customers, but local fuel savings are minimal and lines are long.
- Costco's management has navigated significant challenges, including tariffs and pandemic disruptions, better than many peers.
- Despite lower profit margins due to tariffs, overall profits have increased as higher costs are passed to consumers.
- Costco is expected to grow free cash flow significantly by expanding locations, especially internationally.
- Even after the recent price drop, Costco stock is still considered overvalued and rated as a hold.
DETAILED ANALYSIS
Costco's stock has experienced a notable decline, falling from approximately $1,100 to below $946 per share after its latest quarterly results failed to impress investors. The company's report highlighted record sales of gasoline, driven by rising fuel prices, which in turn attracted more customers seeking fuel savings. However, the actual savings at the pump are modest in some regions, and long lines at Costco gas stations may offset the benefit for some consumers.
Despite these operational nuances, Costco continues to report strong customer traffic and robust sales figures.
In revising his discounted cash flow valuation, Parkev Tatevosian lowered his expectations for Costco's free cash flow over the next several years but also reduced the company's risk profile. The last five to seven years have presented Costco with unprecedented challenges, including the pandemic, shifting tariffs, and economic volatility. Management has responded effectively, maintaining profitability even as tariffs increased costs.
By passing some of these higher costs onto customers, Costco and other major retailers have seen nominal profit growth, despite thinner margins. For example, a product that once cost $1 to import and sold for $2 now incurs a 25% tariff, raising the cost to $1.25. Even with a smaller profit margin, the higher sales price results in increased nominal profit.
Looking ahead, Costco is projected to generate $7.76 billion in free cash flow in 2026, with estimates rising to $20 billion by 2035. This growth is largely attributed to the potential for new store openings, particularly in international markets, as the company currently operates fewer than 1,000 locations worldwide compared to Walmart's 10,000. The analysis uses a discount rate of 8.99%, reflecting Costco's low borrowing costs and reduced risk.
After recalculating the fair value of Costco shares at $759, Tatevosian finds the current market price of $946 to be significantly overvalued, even with a margin of safety. As a result, he maintains a hold rating, emphasizing that while Costco remains a high-quality business, its current valuation does not offer an attractive entry point for investors.
LINKS
- YouTube channel membership for early access, spreadsheets, and Discord community.
- Special Motley Fool Stock Advisor offer.
- Parkev Tatevosian's book on stock evaluation framework.
- Fiscal.ai investment research platform with viewer discount.
- Webull investing platform with bonus shares offer.
- Substack newsletter subscription for monthly updates.