Declining Stock and Solid Fundamentals: Is The Market Wrong About Costco Wholesale Corporation (NASDAQ:COST)?

With its stock down 5.0% over the past month, it is easy to disregard Costco Wholesale (NASDAQ:COST). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Costco Wholesale's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Costco Wholesale is:

30% = US$7.6b ÷ US$26b (Based on the trailing twelve months to February 2025).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.30 in profit.

Check out our latest analysis for Costco Wholesale

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Costco Wholesale's Earnings Growth And 30% ROE

First thing first, we like that Costco Wholesale has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. Probably as a result of this, Costco Wholesale was able to see a decent net income growth of 14% over the last five years.

We then compared Costco Wholesale's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 11% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is COST fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Costco Wholesale Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 26% (implying that the company retains 74% of its profits), it seems that Costco Wholesale is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Costco Wholesale has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 22% of its profits over the next three years. Accordingly, forecasts suggest that Costco Wholesale's future ROE will be 26% which is again, similar to the current ROE.

Conclusion

Overall, we are quite pleased with Costco Wholesale's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.