Costco Wholesale (NASDAQ: COST) is one of the best performing stocks in the retail sector.
Shares of the membership-based warehouse chain have risen more than 600% in the past decade, and the company continues to grow both through new stores in the US, as well as by increasing same-store sales and expanding its e-commerce business expand.
Despite that success, however, there’s a good argument that Costco is now overvalued. The stock trades at a price-to-earnings (P/E) ratio of 56, about double that of the S&P500 index.
You don’t have to follow my opinion on the valuation. Top billionaire investors sold the shares in the second quarter. That includes Ray Dalio’s Bridgewater Associates, which sold 94,000 shares of Costco stock in the second quarter, worth nearly $80 million at the time.
Meanwhile, Ken Griffin’s Citadel Capital dumped 124,000 shares, or about $100 million. While Costco’s business looks strong, it’s likely that these two hedge funds concluded that its valuation was coming under pressure.
If you’re thinking of following them out of Costco, here are two retail stocks worth cashing in on.
1. Home Depot
Home Depot (NYSE: HD) is the nation’s largest home improvement retailer.
While Costco shares have continued to rise since the pandemic, Home Depot has struggled with the housing market slowdown and the stock is still trading below its all-time high from 2021.
However, Home Depot seems well positioned to move higher from here on out. First, the Federal Reserve has begun its rate-cutting cycle, cutting the Fed funds rate by 50 basis points last week.
Falling interest rates should help revive the housing market, lower mortgage rates and monthly payments, and alleviate the lock-in effect of low mortgage rates. It will also lower rates on mortgage loans and home equity lines of credit (HELOC), encouraging renovations and other home improvement projects.
Home Depot is also poised to benefit from the recovery thanks to its acquisition earlier this year of SRS Distribution, a leading building materials distributor. This deal will help Home Depot further integrate vertically, closer to its professional customers, and expand its addressable market by an estimated $50 billion.
Home Depot’s stock now trades at a price-to-earnings ratio of 27. That may seem expensive, but earnings growth should recover as the housing market rebounds.
2. Purpose
Goal (NYSE: TGT) has also been struggling lately, but for different reasons than Home Depot.
As primarily a discretionary retailer, Target has been hit by the slowdown in consumer spending and by internal issues such as theft, but the company now appears to be overcoming these and the company is moving in the right direction.
Meanwhile, inflation now appears to be under control, and falling interest rates should also encourage consumer spending.
Target’s recent challenges have also fueled a sharp recovery in earnings, as reflected in its second-quarter results. Gross margin increased to 28.9% from 27% in the year-ago quarter due to cost improvements, favorable category mix and other factors.
That gross margin improvement flowed through and made a significant difference in operating income, as operating margin improved from 4.8% to 6.4%. In other words, if the company can continue to make significant improvements in gross margin, profits could rise from this point.
Like Costco, Target continues to open new stores, and the company benefits from a number of competitive advantages, including its multi-category business model, store-based fulfillment of online orders and a curbside pickup program.
Target is a stronger company than its recent performance has indicated, and it looks like a good buy with a price-to-earnings ratio of 16. Analysts also expect similar earnings growth from Target and Costco next year, showing that Target looks like a bargain compared to the much more expensive Costco.
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Jeremy Bowman has positions in Target. The Motley Fool holds positions in and recommends Costco Wholesale, Home Depot, and Target. The Motley Fool has a disclosure policy.
Billionaires sell Costco. These two retail stocks are better buys. was originally published by The Motley Fool
