On the JSE, some retailers are trading at a p:e that causes even a few growth investors, let alone value investors, to scratch their heads.
Everything is bigger in ’Murica though, including the earnings multiples of their favourite retailers. Costco is trading on a casual p:e of 60, more than double even the best South African retailers. At this stage, the market is happy to buy these companies on an earnings yield that is way below the US 10-year bond yield. Costco is more appealing than Uncle Sam, apparently.
A chart of the earnings multiple over time tells you everything you need to know about the recent macroeconomic environment of loose lips and even looser monetary policy. At the height of the late-2007 bull market, before the global financial crisis, Costco’s p:e peaked at about 30. By the bottom of that crash, the multiple had dropped by more than half. It took until 2014 to get above 30 again, followed by a fairly steady period in which it ticked up to 35 by the end of 2019. Then along came the pandemic and tons of stimulus, cementing Costco in the minds of investors as a safer bet than the US government.
The result of all that money printing? Costco shot up to trade on a five-year average multiple of 44. In other words, the recent average multiple is nearly 50% higher than the peak multiple before the global financial crisis. It’s little wonder that many investors simply will not touch this thing, terrified that sanity might suddenly prevail.
It’s little wonder that many investors simply will not touch this thing, terrified that sanity might suddenly prevail
The current multiple is roughly double the peak in 2007, so a 50% drawdown in the share price would take it back to levels that were once seen as frothy. Whether such a drawdown is possible is highly debatable though, as the chart has enjoyed $900 a share as a strong support base in recent months. That’s about 13.5% below current levels — painful, but hardly catastrophic.
Against this backdrop of market support, you would hope to see spectacular earnings growth to give credence to the multiple. Costco has certainly been a strong performer, with a 10-year compound annual growth rate (CAGR) of 12.9% in earnings. The share price CAGR over the same period is about 22% though, so multiple expansion is responsible for a significant chunk of those gains.
But just how defensive is this business and how exciting are the growth prospects? Even if the traded multiple is steady at the current levels (by no means guaranteed), is there enough here to justify a long position?
To take this view, you would have to get your head around the very real risk of a drop to $900 and the nontrivial possibility of a far more severe drawdown. The most obvious catalyst for this would, of course, be President Donald Trump’s tariffs, even though he suffered a bloody nose in court in the past week. There were no fewer than 34 appearances of the word “tariff” in the latest Costco transcript, so it’s clear where the market focus is.
Despite all the uncertainty, Costco’s earnings make it clear that growth is still the theme. With the third quarter, the expectation is that 24 net new warehouses (their word for stores) will have opened in financial 2025, taking the global total to 914. This includes locations in Australia, Sweden, South Korea and Canada — so Costco is more than just a US business. Net sales increased 8% for Q3 and net income was up 13%. The model is working.
The company is famous for its Kirkland Signature brand, which is the global case study for what is truly possible in private label. Selling everything from golf balls to nuts and cheese under this brand, Costco has the flexibility to move more of the product sourcing to local suppliers, helping to offset some of the tariff impact. And with just under 80-million paid household members (you pay a membership fee to shop at Costco), they have a vast customer base for these products.
Still, with roughly one-third of US sales being imported goods and 8% of US sales being items imported from China, Costco is going to find it difficult to avoid price increases if tariffs go ahead. It has all the buying and negotiating power in the world, but it can’t work miracles. And at a p:e of 60, the market is pricing in miracles for America’s sweetheart.
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