Much as I’d love to follow Peter Lynch’s advice and invest in companies I love as a consumer, it becomes significantly harder when those companies are trading at sky-high valuations.
One such company is Costco—a fan favorite for many of us, whether for its bulk bargains or the $1.50 hot dog combo. But Costco, the stock, has recently traded at eye-watering P/E (Price/Earnings) multiples approaching 60, making it more of a “browsing stock” than something you’d toss into your investment cart.
Shock and Awe
While casually browsing the holdings of the Avantis U.S. Large Cap Value ETF (AVLV), I did a double take—Costco was one of the top 10 holdings.
Even more surprising: its weight in the fund was greater than its weight in the S&P 500.
Wait… what?
How could a firm like Avantis, known for its quantitative discipline and value-driven approach, include a company trading at such lofty multiples in a value ETF—and give it an above-average weight?
Was Tesla next on the list?
The Plot Thickens
I knew that Avantis uses a combination of adjusted Price-to-Book (P/B) and adjusted Price-to-Earnings (P/E) ratios to rank stocks. Costco, to my knowledge, hasn’t done any major acquisitions, so its adjusted P/B should be very close to its reported figure—and that figure is high, roughly 12x, comparable to some tech names.
With both P/B and P/E running hot, I figured: this must be an error in their model.
Moment of Truth
I quickly sent an email to my ever-helpful Avantis counterpart to flag what I thought was a rare glitch in their quant matrix. A few emails and one Zoom call later—with a very patient analyst on the other end—my gleeful joy at unearthing the “find of the century” was gently laid to rest.
Here’s what I learned:
Context Matters in P/B
While Costco’s P/B ratio is high, its adjusted P/B—relative to other large-cap stocks in the large cap universe—puts it only in the 60th percentile. High, yes, but not disqualifying.
Cash-Based Profitability Tells a Different Story
Avantis doesn’t rely on Net Income to assess profitability. Instead, they use a cash-based operating profitability metric, which excludes non-cash items like depreciation and adjusts for interest and taxes. This gives a clearer picture of how much cash a company actually generates.
And Costco? It shines.
Thanks to:
- Upfront collection of membership fees
- Delayed payments to suppliers
- Low inventory holding periods
- Depreciation from store buildouts
…Costco ranks well above average in cash-based profitability. According to Avantis, it lands in the top quartile of large caps using this metric.
The Composite Score Still Wins
Even after factoring in its elevated P/B, Costco’s composite score using Avantis methodology, combining valuation and cash profitability, places it high in the rankings.
Key Takeaways
- Using one simple ratio like P/E to judge whether a stock is expensive or not is a bad idea
- In an environment where most large-cap valuations are elevated by almost every possible metric, even “value” stocks can look expensive by historical standards.
- And most importantly: Trying to find “cheap” stocks in an expensive market is like trying to find clearance items in a luxury store. You can try—but set your expectations accordingly.