This Undervalued Stock is a Must-Own

The Costco stock price has managed to recover from a recent sell-off. The company prevailed even in the pandemic e-commerce wave.

But Costco stock still looks cheap today. If it’s not yet obvious to you yet, it should be here…

Legendary investor and billionaire Charlie Munger has just four investments in his family’s portfolio. Costco represents a good amount of that.

He owns Berkshire Hathaway Inc. (NYSE: BRK.A), where he and Warren Buffett built an enormous empire.

He owns shares of Daily Journal Corp. (NASDAQ: DJCO), a newspaper and software business, as of 1977.

Munger invests in Himalaya Capital, the hedge fund run by Li Lu, a man often called the “Warren Buffett of Asia.”

And lastly, Munger holds a massive stake in Costco Wholesale Corp. (NASDAQ: COST), the warehouse retailer where he sits on the board.

Of all his investments, Munger calls Costco “one of the most admirable capitalistic institutions in the world.” He counts CEO Jim Sinegal one of the “most admirable retailers to ever live on this planet.”

“I just can’t say enough about my admiration for Costco,” says Munger.

Here’s a clue to why Munger loves Costco so much…

Why Costco Stock Is Undervalued

One school of thought says Costco is overpriced because of its price/earnings (P/E) ratio over 30.

However, Costco shares have traded pretty much continuously with a P/E ratio of over 30 since 2015. Investors who accepted the suggestion to avoid the stock already missed an opportunity to earn about 20% a year on their investment since then.

The price of the stock tripled in the last five years.

Costco presents one of those rare corporations that customers, employees, and shareholders love. It offers fantastic bargains on items for its customers and shaves thousands of dollars off the cost of grocery and household goods.

It pays employees well above the market averages.

As the circular that shows up every month reminds us, Costco sells more than groceries. You will find gasoline, tires, eyeglasses, prescriptions, appliances, TVs computers, and just about anything else you may need or want to buy.

Today, Costco has the highest sales per square foot at $1,400, which trounces competitors, including the biggest warehouse competitor, Sam’s Club, which has sales per square foot of around $800.

Simply, Costco excels at what it does. And that will keep it around for a while…

What to Expect from the Costco Stock Price

The heart of Costco’s business model lies in the fact that it makes most of its money from membership sales. This means that, unlike most retailers, it does not need to mark up the items it sells to turn a profit and grow the business.

It just needs to sell new memberships.

It doesn’t have to worry too much about replacing those who don’t renew, because most of them renew.

Ninety percent of Costco members renew their membership every year.

Costco proves itself Internet-resistant to a substantial degree as well. Even as Amazon and other retailers aggressively position themselves to grab sales in a pandemic, the bargains it provides keep people heading to Costco throughout the year.

Costco may actually have a huge advantage over Amazon. In a Costco warehouse, you can see and touch every item before you buy it. The fact that Costco does not need massive retail markup to make money means that you can purchase some things at the same or even lower than they are offered online.

Costco’s in-house brand of products (Kirkland) can be bought online, but only at Costco.com.

No one at Costco loses sleep worrying about Amazon’s impact on top-line sales. Few retailers can say this.

That all makes Costco a great business. Analysts almost universally consider it a buy and hold for a long time, as Munger does.

Costco management has generously rewarded shareholders in the last few years. It uses about 10% of the company’s cash flow every year to buy back stock.

While the dividend yield of 0.77% looks low on an absolute basis, it has a fantastic history of increasing the payout at a double-digit rate every year. It has also paid out a special dividend every other year since 2013. We expect that to continue.

Costco stock has also reversed its sell-off from earlier this year. The shares are back above the 200-day moving average and appear to be headed higher.

If you worry about a market sell-off happening anytime soon or want to trade Costco in a shorter time frame, you can put a stop at the 200-day moving average of $348.

If you decide not to buy Costco at current levels, I would certainly have it on my “buy in a crash” list.

— Money Morning Staff

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Source: Money Morning