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Here is a look at how Costco Wholesale Corp (NASDAQ:COST) fares in ModernGraham's opinion, based on an updated and modernized version of Benjamin Graham's requirements of defensive and enterprising investors from The Intelligent Investor:

Defensive and Enterprising Investor Tests (What is the significance of these tests, and what is PEmg ratio?):

Defensive Investor - must pass at least 6 of the following 7 tests: Score = 4/7

  1. Adequate Size of Enterprise - market capitalization of at least $2 billion - PASS
  2. Sufficiently Strong Financial Condition - current ratio greater than 2 - FAIL
  3. Earnings Stability - positive earnings per share for at least 10 straight years - PASS
  4. Dividend Record - has paid a dividend for at least 10 straight years - PASS
  5. Earnings Growth - earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period - PASS
  6. Moderate PEmg ratio - PEmg is less than 20 - FAIL
  7. Moderate Price to Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50 - FAIL

Enterprising Investor - must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5

  1. Sufficiently Strong Financial Condition, Part 1 - current ratio greater than 1.5 - FAIL
  2. Sufficiently Strong Financial Condition, Part 2 - Debt to Net Current Assets ratio less than 1.1 - FAIL
  3. Earnings Stability - positive earnings per share for at least 5 years - PASS
  4. Dividend Record - currently pays a dividend - PASS
  5. Earnings growth - EPSmg greater than 5 years ago - PASS

Valuation Summary (Explanation of the ModernGraham Valuation Model)

Key Data:

MG Value$109.69
MG OpinionFairly Valued
Value Based on 3% Growth$61.39
Value Based on 0% Growth$35.99
Market Implied Growth Rate9.67%
NCAV-$8.24
PEmg27.83
Current Ratio1.17
PB Ratio4.62

Balance Sheet - 9/30/2013

Current Assets$17,473,000,000
Current Liabilities$14,933,000,000
Total Debt$4,987,000,000
Total Assets$32,319,000,000
Intangible Assets$0
Total Liabilities$21,098,000,000
Outstanding Shares439,720,000

Earnings Per Share

2014 (estimate)$4.76
2013$4.63
2012$3.89
2011$3.30
2010$2.92
2009$2.47
2008$2.89
2007$2.37
2006$2.30
2005$2.18
2004$1.85
2003$1.53

Earnings Per Share - ModernGraham

2014 (estimate)$4.23
2013$3.79
2012$3.28
2011$2.92
2010$2.68
2009$2.52

Conclusion:

Costco Wholesale Corp is a great place to shop at, but not such a great company to invest in presently. The company does not qualify for the Defensive Investor because its current ratio is too low, and it is currently trading at high PEmg and PB ratios. The Enterprising Investor also does not like Costco right now because the company has too much debt relative to its current assets. As a result, value investors may seek to find other opportunities, beginning with a review of ModernGraham's valuation of Target Corp (NYSE:TGT).

From a valuation perspective, the company does appear to be trading at a fair price. The EPSmg (normalized earnings) have grown from $2.52 in 2009 to an estimated $4.23 for 2014, and the growth has been consistent over the time period. The market is currently implying a growth rate estimate of 9.67%, which is in line with what has been seen historically. As a result, the company appears to be fairly valued.

What do you think? Do you agree that Costco Wholesale Corp is fairly valued? What would be your assessment? Is the company not suitable for Defensive Investors or Enterprising Investors?

Disclosure: The author did not hold a position in Costco Wholesale Corp (COST) at the time of publication and had no intention of changing that position within the next 72 hours.

Source: ModernGraham Valuation Of Costco Wholesale Corp