It made me think about Costco (COST), a company I love, with its sky-high P/E ratio of 61.72.
Yahoo! Finance
Then Marks explained something that grabbed me: buying a stock at a P/E of 16 (the historical average since WW2) means you’re paying for 20+ years of a company’s future earnings discounted back to today.
Because of inflation, today’s dollar is worth more than tomorrow’s. If a company would make $1M next year and then shut down, you’d pay less than $1M to get a positive return.
It clicked that at Costco’s current P/E of 61.72, I’m paying $62 for each $1 of annual earnings – for a company that’s only existed for 42 years! To justify today’s price based solely on current earnings (with no growth), you’d need Costco to maintain its performance for far longer than it has even existed.
So I’m sticking to my guns and waiting for a better price, even if it means missing out. After all, the S&P 500 just had its best two-year run since right before the dot-com bubble burst. Marks’ data shows that whenever people bought the S&P at P/E ratios similar to today’s 22x multiple, they earned ten-year returns between +2% and -2%.
I’m also content getting my Costco exposure through an S&P 500 index fund. Looking at the latest weightings, Costco is ranked #16, meaning about $0.91 of every $100 I invest in the S&P 500 flows into Costco. Of course, this works both ways—if market sentiment shifts and selling begins, that amount flows out just as automatically.
SlickCharts.com
Companies trading at high P/Es are essentially “priced for perfection.” Any stumble, any slight miss in earnings, and the stock gets hammered. You’re paying a premium for flawless execution and continued high growth.
Sometimes it’s okay to say “if I miss it, I miss it” – there will always be other opportunities. The market doesn’t reward FOMO investors in the long run.
And, Costco’s P/E is WAY above the sector average of 17X earnings. Using Costco’s 5-year average P/E of 37 and their current earnings per share of $18 would give us a share price of $686. But, given that Costco is a dominant company, I’d feel comfortable paying a 10% – 20% premium and buying in the $750 to $800 range.
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