Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. Â This isÂ best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another companyÂ or by reviewing theÂ 5 Most Undervalued Companies for the Defensive Investor – December 2014.Â By using theÂ ModernGraham methodÂ one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. Â What follows is a specific look at how Costco Wholesale Corporation (COST)Â fares in theÂ ModernGraham valuation model.
Company ProfileÂ (obtained fromÂ Google Finance):Â Costco Wholesale Corporation (Costco) is engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, and through majority-owned subsidiaries in Taiwan and Korea. The Company operated 663 membership warehouses and an average warehouse is approximately 144,000 square feet. The Companyâ€™s warehouses generally operate on a seven-day, 69-hour week. The Companyâ€™s product categories include Food, Sundries, Hardlines, Fresh Food, Softlines, Ancillary and Other. The Companyâ€™s online business provides products, which include services, such as photo processing, pharmacy, travel, business delivery, and membership services.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion -Â PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 -Â FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years -Â PASS
- Dividend Record – has paid a dividend for at least 10 straight years -Â PASS
- 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
- Moderate PEmg ratio – PEmg is less than 20 -Â FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 -Â FAIL
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 3/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 -Â FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 -Â FAIL
- Earnings Stability – positive earnings per share for at least 5 years -Â PASS
- Dividend Record – currently pays a dividend -Â PASS
- Earnings growth – EPSmg greater than 5 years ago -Â PASS
|Value Based on 3% Growth||$66.19|
|Value Based on 0% Growth||$38.80|
|Market Implied Growth Rate||11.31%|
Balance Sheet – NovemberÂ 2014
Earnings Per Share
Earnings Per ShareÂ – ModernGraham
Costco Wholesale CorporationÂ is not suitableÂ for either the Defensive Investor or the Enterprising Investor. Â The Defensive Investor is concerned with the low current ratio, and the high PEmgÂ and PBÂ ratios. Â The Enterprising Investor is concerned with the level of debt relative to the current assets. Â As a result, value investorsÂ following the ModernGraham approach based on Benjamin Graham’s methods should exploreÂ other opportunities. Â As for a valuation,Â the company appears to be overvaluedÂ afterÂ growingÂ its EPSmg (normalized earnings) from $2.92 in 2011 to an estimated $4.56 for 2015. Â This level of growth does not support the market’s implied estimate of 11.31% growth, leading the ModernGrahamÂ valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value well belowÂ the price.
Be sure to check out previous ModernGraham valuations of Costco Wholesale Corporation (COST)Â for greater perspective!
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. Â What do you think? Â What value would you put on Costco Wholesale Corporation (COST)? Â Where do you see the company going in the future? Â Is there a company you like better? Â Leave aÂ comment on ourÂ Facebook pageÂ or mentionÂ @ModernGrahamÂ on Twitter to discuss.
Disclaimer: Â The author did not hold aÂ position in Costco Wholesale Corporation (COST)Â at the time of publication and had no intention of changing that position within the next 72 hours. Â Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.