Should You Buy the Dip on Costco Wholesale Stock?

For a while, it looked like Costco Wholesale (NASDAQ: COST) stock would continue climbing without end. Despite a seemingly high valuation, investors were willing to pay a sizable premium for the company.

The business has also looked unstoppable, performing well while other retailers have struggled.

In recent months, however, the stock has been in a bit of a tailspin. Its shares lost 11% of its value in six months, and recently were down around 15% from the company's 52-week high of $1,078. Could this be a golden opportunity to buy shares of one of the top retail stocks in the world?

Image source: Getty Images.

Costco has been a resilient business over the years

Although Costco's growth slowed down in recent years, the company has consistently remained in positive territory. Single-digit growth is nothing to scoff at these days, as many customers are struggling amid higher prices and worsening economic conditions. Costco's business has done considerably well given the circumstances.

COST Revenue (Quarterly YoY Growth) data by YCharts

Costco has a fantastic business model that relies on membership fees to keep prices down. Plus, its treasure hunt experience makes it nearly inevitable for people to spend much more than they planned to when visiting one of its warehouses. Waiting or thinking over a purchase at Costco can result in missing out on it entirely the next time you're there. That urgency leads to a lot of impulse buys.

Whether consumers have a lot of disposable income or are cutting back and looking for ways to save, Costco has been a popular go-to option for shoppers. And it's the company's strong resilience that continually makes it an attractive option for growth investors to include in their portfolios.

But despite its impressive results, the retail stock is not necessarily a good buy at any price.

Its high valuation made the stock due for a drop

The biggest knock on Costco's stock price was always that it was extremely overvalued. Paying 20 or 30 times earnings might be justifiable for a company growing in the mid- to high single digits, but Costco is well above that range. Even with its recent decline, the stock is trading at a price-to-earnings (P/E) multiple of more than 50. Investors may be loving the stock a bit too much.

COST PE Ratio data by YCharts

The stock has averaged a five-year P/E of around 45, and at its peak, its P/E topped 60. Although it has come down a bit, it's still a bit rich in value.

I wouldn't rush to buy Costco's stock today

The problem with Costco's stock is that, while the business is sound and the financials are strong, the stock price itself is simply too high. The danger is in falling in love with a stock and thinking that it's a buy regardless of the price. Not only could that limit your returns, but you could also incur losses on a quality stock simply because you bought it at a high valuation. It leaves you with no margin of safety; high expectations are baked into the price, and if the company falls short, that could lead to a sharp sell-off.

Costco's stock is still looking far too expensive for it to be a good buy right now, especially when there are many other growth stocks out there you can buy and that are trading at much more reasonable valuations. Costco is a stock worth putting on a watch list, but with its valuation being as high as it is, I wouldn't be surprised if it continues to decline in the near future.

David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale. The Motley Fool has a disclosure policy.