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In this article, we want to take a closer look at Costco Wholesale Corporation (COST) by examining it from a fundamental and technical perspective. However, before we get to that stage, we always put the company through an initial screen in order to make sure it fulfils certain basic requirements. Costco Wholesale Corporation was put through the screening process outlined below, and it fulfilled or exceeded all the listed requirements. One thing investors should keep in mind is not to base their investment decisions on the yield only. Other factors such as quarterly earnings growth, number of consecutive dividend increases, dividend growth rate, interest coverage ratio, revenue growth rates, the retention ratio, etc. should be taken into consideration also.

The screening process:

  1. A positive levered free cash flow
  2. Consecutively increased the dividend for 5 years or more
  3. An interest coverage ratio above 25
  4. A retention ratio of 70% or higher (this figure is obtained by subtracting 1 from the payout ratio)
  5. Net income should be trending upwards for the past 3 years
  6. Cash flow per share should be trending upwards for the past 3 years
  7. A quarterly earnings growth rate of 15% or higher
  8. Annual EPS before NRI should be trending upwards for the past 3 years
  9. A 3-5 year estimated ESP growth rate of 10% or higher.

Points of interest

  1. Strong positive levered free cash flow of $1.86 billion
  2. An excellent interest coverage ratio of 27.5
  3. EPS, cash flow and net income have been trending upwards for the past 3 years.
  4. A good 3-5 estimated EPS growth rate of 12.8%
  5. Dividends have been consecutively raised for 7 years and it sports a healthy 5 year dividend growth rate of 13.3%.
  6. A low payout ratio of 26% and an excellent retention rate of 74%.
  7. A strong quarterly earnings growth rate of 27%

Charts and tables of value

Historically, stocks tend to perform better when they are trading above the EPS consensus estimate line. The stock is trading well above the EPS consensus line and so the outlook is still bright. It would have to drop significantly lower to trade below this line.

$100K invested 10 years ago would have grown to $272K as indicated in the chart below. We simply multiplied the result by 100 to arrive at our answer. The table below uses a starting value of 1K.

The competition

Costco will be compared with two competitors using several key metrics such as P/E, quarterly revenue growth, operating margins, PEG, etc. This will give you further insight into the company. It could also help you determine if Costco is the right play for you. Perhaps you might find one of its competitors makes for a more compelling play.

COST

(TGT)

(WMT)

Industry

Quarterly revenue growth

0.14

0.03

0.05

0.07

Revenue

99.14B

71.34B

460.71B

6.97B

Gross Margin

0.12

0.30

0.25

0.30

EBITDA

3.67B

7.47B

35.70B

910.35M

Operating Margin

0.03

0.07

0.06

0.06

Net Income

1.71B

2.94B

16.30B

N/A

EPS

3.89

4.36

4.74

2.61

P/E

24.79

14.48

15.86

20.69

PEG (5 yr expected):

1.70

1.18

1.65

1.19

P/S

0.42

0.58

0.55

0.84

M= Million B= Billion

Technical outlook

The stock is still in a corrective phase and will most likely trade to the $90.50-$91.00 ranges before it finds any support. The support offered in this zone is not very strong. A weekly close below $89.50 could result in a test of the $83.50-$84.00 ranges where it has a very strong level of support. Consider dividing your money into two portions and then use one portion when the stock trades down to the $90.50 -$91.00 ranges and the second portion if the stock tests the $83.50-$84.00 ranges. Alternatively, you could always sell puts when the stock trades down to $90.50 or better. If the shares are assigned to your account, your final entry price will be a lot lower than someone who put in a simple limit order at $90.50 or better. If the shares are not assigned to your account, you will at least get paid for your troubles via the premium you received when you sold the puts.

On a separate note, the stock is trading above its 200 moving day average, which is generally viewed as a long term bullish development.

Fundamental data

The data below should easily enable you to decide if this stock meets with your investment objectives. Some of the key areas to pay attention to are sales, net income, interest coverage ratio, current ratios, profit margins, cash flow and 3-5 year projected EPS growth rates. For those who are not familiar with the interest coverage ratio, retention rate and current ratio, we have provided a brief explanation of both below. In the case of Costco, we can see that net income, cash flow per share, sales and EPS has been trending upwards for the past three years. Net income has actually been trending upwards for the past four years, and in the Annual EPS before NRI has been generally trending up for the past five years.

The retention ratio is the amount of net income that is not paid out as dividends. In other words, it is the money the company retains that can be used to grow the business, etc. It is calculated by subtracting 1 from the dividend ratio.

The Interest coverage ratio informs you of a company's ability to make its interest payments on its outstanding debt. Lower interest coverage ratios indicate that there is a larger debt burden on the company and vice versa. For example if a company has an interest ratio of 11.8, this means that it covers interest expenses 11.8 times with operating profits.

The Current Ratio allows you to see if the company can pay its current debts without potentially

Company: Costco Wholesale Corporation

Key Ratios

  1. Consecutive dividend increases = 7 years
  2. Three year dividend growth rate = 6.95%
  3. Profit Margin = 1.72%
  4. Quarterly Revenue Growth = 14.3%
  5. Quarterly Earnings Growth = 27.4%
  6. Levered free cash flow =$1.86B
  7. Sales versus 1 year ago = 11.5%
  8. 5 year EPS growth rate = 8.75%
  9. Total return last three years = 69%

Growth

  1. Net Income ($mil) 09/2012 = 1702
  2. Net Income ($mil) 09/2011 = 1462
  3. Net Income ($mil) 08/2010 = 1303
  4. Net Income ($mil) 08/2009 = 1086
  5. Net Income Reported Quarterly ($mil) = 609
  6. EBITDA ($mil) 12/2011 = 3354
  7. EBITDA ($mil) 12/2010 = 2960
  8. EBITDA ($mil) 12/2009 = 2563
  9. Cash Flow ($/share) 12/2011 = 5.29
  10. Cash Flow ($/share) 12/2010 = 4.81
  11. Cash Flow ($/share) 12/2009 = 4.25
  12. Sales ($mil) 12/2011 = 88915
  13. Sales ($mil) 12/2010 = 77946
  14. Sales ($mil) 12/2009 = 71422
  15. Annual EPS before NRI 12/2007 = 2.63
  16. Annual EPS before NRI 12/2008 = 2.91
  17. Annual EPS before NRI 12/2009 = 2.54
  18. Annual EPS before NRI 12/2010 = 2.95
  19. Annual EPS before NRI 12/2011 = 3.3

Dividend history

  1. Dividend Yield = 1.2%
  2. Dividend Yield 5 Year Average = 1.2%
  3. Dividend 5 year Growth = 13.3%
  4. Payout Ratio = 0.26
  5. Payout Ratio 5 Year Average = 0.26

Performance

  1. Next 3-5 Year Estimate EPS Growth rate = 12.85
  2. ROE 5 Year Average = 12.86
  3. Current Ratio = 1.10
  4. Current Ratio 5 Year Average = 1.12
  5. Quick Ratio = 0.50
  6. Interest Coverage = 29.5
  7. Retention rate= 74

Conclusion

This is a good long term play to have in your portfolio. It sports an excellent five-year dividend growth rate of 13.3%. It has consecutively increased the dividend for 7 years, has a very low payout ratio 26%, and a good quarterly earnings growth rate of 27%. The stock is still correcting, and we would wait for the stock to trade down to the $90.50-$91.00 ranges before opening a new position. It would be better to divide the money you expect to invest into two ports. Deploy one portion if it trades in the $90.50-$91.00 ranges and the second if it happens to trade in the $83.50-$84.00 ranges.

EPS and EPS surprise charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Dividend history sourced from dividata.com.

Disclaimer

It is imperative that you do your due diligence and then determine if the above play meets with your risk tolerance levels. The Latin maxim caveat emptor applies-let the buyer beware.

Source: Costco: A Good Play But Wait A Bit Longer Before Jumping In