Can Costco Stock Hit New Highs as Interest Rates Drop?

An apparent tailwind hit yesterday's value stocks, a new development seen in the declining shares of Costco Wholesale Co. COST after the company released its latest set of quarterly earnings this week. Costco stock is now down over 2% after the report, a bearish sentiment that comes despite the Federal Reserve (the Fed) recently cutting interest rates by the most since the 2008 financial crisis.

However, some investors argue these rate cuts might have been priced into stocks like Costco and Walmart Inc. WMT. However, some of this momentum has not worked its way through stocks like Dollar General Co. DG, which supposedly offer more value to the consumer. In today's economy, value isn't enough. Markets seem to prefer economies of scale and big enough cash flows to enable management to reinvest in technology and efficiency.

The consumer staples sector could become the main preference for investors during this consumer uncertainty, the question becomes whether Costco can still deliver more upside after pricing in interest rate cuts and trading as high as a 55.0x price-to-earnings (P/E) ratio today. This can be answered by comparing the recent company results to what Wall Street analysts now expect to see out of the company moving forward.

Costco Stock's Strong Financials Set High Expectations for Future Growth

Starting with the most common driver, the top line. Costco delivered a net increase in revenues of 1.0% over the past 12 months, which may have been enough to lower the stock since inflation over the year was clearly above what Costco managed to push out in revenues.

However, the way revenues grew is more important than the net. Comparable sales rose by 5.4%, a retail sector metric indicating whether growth is coming from opening new locations or from higher demand and traffic in existing stores. Considering that traffic was up 6.4% in the year for Costco stores, investors can assume the latter is the case.

Another interesting metric investors should pay attention to in these wholesale value businesses is whether management is shifting with the times. Costco reports an 18.9% growth in e-commerce sales, meaning they are aware of consumer preferences and trends today and are making suitable investments to position Costco for this wave.

This shift in volume and technology drove the company's gross margin higher, to 11%, compared to 10.6% last year. This may not seem like much on a percentage basis, but it was enough to drive the bottom-line net income to $2.35 billion, or 9% higher.

Here is what investors can take away from Costco's trends when in doubt. Membership users grew to 76.2 million this quarter, or 7.3% over last year, driving subscription revenue higher by 6.5% to amplify the stock's potential for stable and predictable cash flows in the future.

The only negative factor working against Costo is its valuation. Some argue that some stocks are expensive for a reason, and while Costco does have enough quality and growth to justify higher multiples, here's what Wall Street has to say about it potentially being too high.

Wall Street's Outlook on Costco Stock and Its Future Growth Potential

The camp is divided, as most Wall Street analysts now have a consensus price target of only $874.6 for Costco stock, which is basically where it trades today, plus or minus 1.5%. Willing to stand out from the pack, those at Goldman Sachs had something else in mind.

These analysts see a $995 share valuation for Costco stock, calling for a further upside of 13.8% from where it trades today. Goldman is not alone in taking a view for further upside in Costco stock, though. Despite the recent price action, bearish traders decided to step away from this name over the past month.

Costco stock's short interest declined by 2.9% during this period, showing signs of potential bearish capitulation today. More than that, those at Legal & General Group decided to boost their holdings in Costco stock by 2.5% as of August 2024, bringing their net investment up to $3.1 billion today.

All of these new bulls may have been looking at Wall Street's earnings per share (EPS) growth forecasts, which now point to Costco swinging to $5.58 for next year, up from today's $5.15, which calls for a 13.6% annual growth rate.

Regarding sentiment, it looks like markets are justified in paying a premium for Costco stock, considering where the company fundamentals have been headed lately. However, recent volatility might shake off a few of the late buyers in Costco stock, an event new buyers might want to watch out for as a potential dip buying opportunity.

The article "Can Costco Stock Hit New Highs as Interest Rates Drop?" first appeared on MarketBeat.