Stock Analysis

Is Costco Wholesale Corporation (NASDAQ:COST) Expensive For A Reason? A Look At The Intrinsic Value

NasdaqGS:COST
Source: Shutterstock
How far off is Costco Wholesale Corporation (NASDAQ:COST) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. I will use the discounted cash flows (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not June 2018 then I highly recommend you check out the latest calculation for Costco Wholesale by following the link below. Check out our latest analysis for Costco Wholesale
Advertisement

What's the value?

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

20182019202020212022
Levered FCF ($, Millions)$2.55k$2.77k$3.44k$3.78k$4.15k
SourceAnalyst x8Analyst x9Analyst x3Analyst x3Analyst x3
Present Value Discounted @ 8.59%$2.35k$2.35k$2.68k$2.72k$2.75k

Present Value of 5-year Cash Flow (PVCF)= $12.85k

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year 'growth' period, we discount this to today's value at a cost of equity of 8.6%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = $4.15k × (1 + 2.9%) ÷ (8.6% – 2.9%) = $75.70k

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = $75.70k / ( 1 + 8.6%)5 = $50.14k

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is $62.99k. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of $143.61. Relative to the current share price of $202.57, the stock is quite expensive and not available at a discount at this time.

NasdaqGS:COST Intrinsic Value June 8th 18
NasdaqGS:COST Intrinsic Value June 8th 18

Important assumptions

I'd like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Costco Wholesale as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I've used 8.6%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For COST, there are three fundamental factors you should look at:

  1. Financial Health: Does COST have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does COST's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of COST? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

New: AI Stock Screener & Alerts

Our new AI Stock Screener scans the market every day to uncover opportunities.

• Dividend Powerhouses (3%+ Yield)
• Undervalued Small Caps with Insider Buying
• High growth Tech and AI Companies

Or build your own from over 50 metrics.

Explore Now for Free

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.

About NasdaqGS:COST

Costco Wholesale

Engages in the operation of membership warehouses in the United States, Puerto Rico, Canada, Mexico, Japan, the United Kingdom, Korea, Australia, Taiwan, China, Spain, France, Iceland, New Zealand, and Sweden.

Flawless balance sheet with solid track record.

Advertisement