Costco Wholesale Corporation (NASDAQ:COST) Investors Are Less Pessimistic Than Expected

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Costco Wholesale Corporation (NASDAQ:COST) as a stock to avoid entirely with its 56.2x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Costco Wholesale certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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What Are Growth Metrics Telling Us About The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Costco Wholesale's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a terrific increase of 16%. The latest three year period has also seen an excellent 46% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 11% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 11% per annum, which is not materially different.

In light of this, it's curious that Costco Wholesale's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From Costco Wholesale's P/E?

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Costco Wholesale's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Costco Wholesale, and understanding should be part of your investment process.

If these risks are making you reconsider your opinion on Costco Wholesale, explore our interactive list of high quality stocks to get an idea of what else is out there.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.