While valuation Cassandras tend to focus on the pricey multiples of artificial intelligence stocks, Walmart and Costco actually trade at richer blended forward price-earnings ratios (34.3 times and 47 times, respectively) than Nvidia Corp (34 times), and the situation is getting less tenable with time. Walmart’s multiple is about 3.3 standard deviations above its 2015–2024 average of 20 and Costco trades at about 1.7 standard deviations above its 10-year average of 34. From a first principles standpoint, it is highly unusual for a pair of earthly retail stocks to have forward earnings yields — the inverse of the price-earnings multiple — that are now significantly more paltry than the yield on a two-year Treasury note. In slightly oversimplified terms, investors are willing to pay more per dollar of next year’s earnings than they are willing to pay for a supposedly risk-free two-year Treasury note with government-guaranteed coupons.
Re-accelerating growth is part of the story. In times of belt-tightening, these companies are taking a larger share of the typical household wallet and gaining influence even among higher-income groups, and Walmart is arguably undergoing a transition into more of an e-commerce company. But these are also relatively mature companies that already have massive footprints, and their total addressable markets are hemmed in by consumer demand, meaning growth prospects cannot be the whole story. Instead, I’d argue that it’s primarily the perception of safety that has so inflated the retailers’ valuations. These stocks are surging because investors believe that they can’t go down! And paradoxically, that now puts them at a heightened risk of correction.
As the story goes, Costco and Walmart are all-weather stocks. Their reputation for good value means they profit in good times and snap up market share when the economy goes south. They burnished that reputation in the 2020–2024 period, which included a pandemic, the worst inflation in 40 years and ultimately aggressive interest rate hikes. Despite it all, Costco and Walmart were among only 48 companies on the S&P 500 that never saw y-o-y declines in either revenue or diluted earnings per share from continuing operations.
Meanwhile, the market performance has been even more impressive than the fundamentals. Since the end of 2019, Costco has returned 250% and Walmart 163%, versus 118% for the S&P 500 overall. Even more impressively, they did so with very little volatility, giving them both top 10 risk-adjusted returns among S&P 500 stocks.
See also: Defence shares rise, conflicts loom on prospect of US stakes
The safety paradox can affect anything in finance and markets. In the bond market example, few people foresaw the supply-chain disruptions that awakened inflation after decades in hibernation, and investors had been lulled into comfort by relentlessly falling borrowing costs. Similarly, up until 2007, many Baby Boomers — acting out of their lived experience — believed that single family housing never lost its value, pushing home values so high that the crash was an avalanche.
In the case of the retailers, the fundamentals might not have to change very much at all — nor should we expect them to — for the stocks to suffer a course correction. In a way, recent macroeconomic trends offered the perfect balance for Walmart and Costco. High interest rates and sticky inflation created an environment in which hiring slowed and consumers became more discerning, but the economy never got so lousy that people started losing their jobs and were forced to cut consumer spending overall. We find ourselves in a unique and unstable sort of equilibrium, and it won’t last forever. Even short of a recession, it might only take a minor growth slowdown, such that investors come to appreciate that demand can’t grow to the sky, to prompt a rethink on the multiples. A return to those previous 10-year average multiples would imply a 39% drop for Walmart and a 28% decline for Costco, holding current 12-month earnings expectations constant.
Famously, the market can remain irrational longer than you can remain solvent, as John Maynard Keynes was believed to have said (though no one’s quite certain if the attribution is really correct). In that sense, even “safety” can be a self-fulfilling prophecy for a substantial period of time: If the public believes something is a no-lose proposition, more and more people will buy it, and the performance will seem to justify the original thesis. In the case of Walmart and Costco, that music has been playing for several years now. At this stage, it is healthy to think about what that tells us about the state of the broader market and, moreover, what will happen when the music inevitably stops. — Bloomberg Opinion
