- The Costco share is rising significantly after a strong earnings report.
- Since then, however, it has fallen as profits at Target and Walmart draw bleak prospects for retail.
- Costco is the fastest growing company, but Target and Walmart also have their benefits.
In the last month, stock prices have been on Costco Wholesale (WKN: 888351, 0.55%), Goal (WKN: 856243, 4.32%) and Walmart (WKN: 860853, -0.61%) has fallen more than 25% – far more than that S&P 500 by 12.5% or Nasdaq Composite by 15.6% during this period. These companies tend to be stable and reliable dividend stocks. So what happens?
The sale comes on the back of general volatility, valuation problems and weak forecasts from Target and Walmart, suggesting that these companies will face increased margin pressure when inflation gets out of control. The good news is that investors who have been waiting to buy shares in these well-known companies can now do so at a cheaper price.
Let’s look at where each company stands and where it might be heading to determine if Costco is the best buy, or if investors could do well with a 50/50 split of Target and Walmart.
The case for Costco
Costco is an exciting company for a number of reasons. First, the company generates revenue from subscriptions, while barely making money on the products it sells. The company’s profits are so small that they’re even lower than Walmart’s – which’s hard to believe.
COSTCO OPERATING MARGIN (LAST 12 MONTHS). DATA FROM YCHARTS
Low margins are not usually a recipe for success. To cope with low margins, a business must either sell enough to still make a lot of money (like Walmart) or grow fast. In his honor, Costco does both.
COSTCO SALES (LAST 12 MONTHS). DATA FROM YCHARTS
Over the past five years, Target’s revenue has grown faster than Costco’s. But Costco has grown its profits faster than Target. So at least for now, Costco’s low margin business is not an issue. And while the normal dividend is just 0.9%, Costco is known for paying large special dividends.
With stocks falling 31% over the past month, the Costco stock may look attractive at first glance.
COST CO. DATA FROM YCHARTS
The case of Walmart and Target
I think a 50/50 split of Walmart and Target is much better than buying Costco right now. The main reason is the assessment.
COSTCO P / E (EXPECTED). DATA FROM YCHARTS
Even after the divestment, the Costco share’s forward price-to-earnings multiple is well ahead of Target and Walmart and ahead of the S&P 500 average of around 18 (and that estimate assumes much higher earnings growth than Costco is likely to achieve).
In addition, Target has delivered impressive growth, especially in e-commerce. Its growth may not be as fast as Costco’s, but it’s certainly much better than Walmarts’. Target’s operating margin of over 8% also provides the company with a buffer if inflation continues. In its earnings announcement for Q1 2022, Target said it aims for an operating margin of at least 8% over the long term. In the first quarter, however, the company had only an operating margin of 5.3% and expects an operating margin of 6% for the full year. Target expects higher than expected shipping costs of over $ 1 billion in 2022 alone.
Therefore, it is only logical that the share price falls in the short term. But Target is a Dividend Aristocrat, meaning a member of the S&P 500 who has paid and increased its dividend for at least 25 years in a row. At the time of writing, the dividend yield on the Target share is 2.2%.
Walmart may not have the growth of Costco or Target. But it has a product mix that leaves less estimate. Walmart’s current mission is: “Save people money so they can live better.” Since its inception, Walmart has focused on providing consumers with the lowest prices for the goods they need. That makes Walmart a natural winner during a recession.
However, inflation has hit the company hard with supply chain problems, higher shipping costs and higher commodity costs. Walmarts already low profit margins are likely to fall even more. But Walmart is probably the cheapest of the three, even though it has a higher price-to-earnings ratio than Target, because its business would be least affected in a real recession. Walmart also offers a yield of 1.9%.
An attractive buying opportunity
Buying equal shares of Target and Walmart is an interesting proposal right now. None of the companies are immune to the challenges of the market. But both are also Dividend Aristocrats, having experienced many business cycles in the past. Through all these phases, they have been able to keep increasing their yields. Both companies have done a good job of expanding into e-commerce and are certainly better positioned than most other retailers.
Plus, investors can expect Target and Walmart to exist for decades to come. The same could be said about Costco. But again, the big difference is the assessment and the product mix. Costco’s high valuation depends on the company continuing to show above-average growth. As growth slows, the Costco stock will appear overvalued. When reading the coffee grounds, one would think that Costco is overrated right now. Its price-to-earnings ratio is more than double that of Targets, though Targets’ growth is also quite decent. Both Costco and Target offer many consumer products that are likely to be less in demand during a downturn. It’s just that Target shares already look cheap, while Costco shares look expensive.
No one knows how serious stock market sales will be. But when inflation cools and profit margins return to normal – whether in a year, three years or whatever – Target and Walmart stocks will just look too cheap to ignore.
No matter how you look at it, it’s hard to imagine that in five or 10 years’ time Target and Walmart will not be bigger companies than they are today. Costco is also likely to be a larger company in five or 10 years. But it could easily underperform Target and Walmart during this time if its growth matches Targets. Costco may also have difficulty paying particular dividends if growth slows, which could cause it to produce much less passive income compared to Target and Walmart.
Target and Walmart complement each other’s strengths and balance their weaknesses – making them an attractive duo that is better than just buying one or the other.
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