Skip to main content

Important update on Costco price! A mistake I made and new update


On July 5th, I posted my first stock valuation of Costco in Link and Link2, and I got a price of $966.17.

However, I learned today that I made a mistake when valuing the equity risk premium in part 1-Link.

If you check the end of the figure below, I used the implied risk premium from the NYU Stern dataset, which is calculated by the expected return of stock -risk-free rate.







But when I calculate the cost of capital, I use the weighted average implied risk premium as market risk premium to calculate the cost of equity. 

But the cost of equity formula is Risk-free rate+Beta*(Expected return of Market-Risk free rate).

So by using implied risk premiums, I mistakenly subtracted risk free rate twice, largely underestimating the cost of equity.



 






In addition, I used 8.99% as a long-term market risk premium for terminal value calculation. The rate is calculated by my own calculation for US stock return for the past 30 years, which can also be biased.









Today, I found these mistakes and corrected them. I first replaced the implied risk premium with the expected return of the equity market in the market equity risk premium calculation.






Then I updated the current WACC(weight average cost of capital), and long-term WACC for terminal value calculation.







As a result, the stock price before the stock option has been decreased to $782.85.

You can also find that the trailing 12 months' Operating income I projected for Costco one year ago is $8019 million, while right now, the actual number is $7942 million from Yahoo Finance. The actual operating income is 99.03% of my prediction, and I think it is not that bad.





In addition to projected stock options, the fair price decreases to $776.28.








Actions:

One thing I want to mention is that if a stock is trading at a fair price, should you buy it? 

I used to think that I should only buy the stock at an undervalued price, mainly because some of my financial professors said, "You want to buy at low and sell at high," a term that is very easy and cheesy to say. But later, I realize that such a word tells you few about trading strategy. Think about it. If you really have a way to value a house, you are interested at 1 million dollars, and the place is trading at 1 million now. Would you buy it or wait for it to get cheaper? I will buy it because it can also go up if I don't buy it. I don't know how undervalued it can go unless there are significant events, such as a recession or expected interest rate hikes due to hyperinflation. There have been several times before when a stock is traded close to its estimated value, and I want to wait for it to be 20-30% undervalued, then I end up missing the opportunity to buy.

But I am not going to buy more Costco stock right now...

Because the 4 shares of Costco stock I bought one year ago have been over 4% of my total portfolio, diversification is one of my investing principal. So I will not buy more.

Instituions

As my course of action, I included instructions' price target update. And you can tell that my valuation is still way higher than the institutions.

I did it not because I cared about their valuation but because I knew that they would not keep a record of what they are saying on their own. If you check my original post Link, you can see their price target half a year ago. And you should notice two things:

1. Whenever one institution updates the price, most others will not only update but update in the same way. You may wonder why? Because most of them go to the same college, play golf and have business dinners together even if they work for different companies, some interesting conversations can happen.

2. The way institutions evaluate analysts is through comparative analysis.

So if all analysts lose 10% on average in a period but you lose 8%, you can keep your job.

But you may be fired if all analysts earn 10% on average and you earn 7%.

So we have different goals. I aim to beat the market and get as high a return as possible, while analysts aim to perform as "industry average." There is no good or bad regarding our goals; they are just different. One is serving for excellence, while the other is mediocre.

I hope you find the post helpful.









Labels:

Comments

Post a Comment

Popular posts from this blog

Costco Stock Valuation Part 2-Growth rate, stock compensations, and Free Cash Flow

Note: I found that I made a serious mistake in estimating the cost of equity in my this valuation; Please check this Link  while reading the free cash flow part. Growth rate forecast The growth rate is among the most challenging number to calculate financial valuation. Because you always have something to base on when calculating the company’s debt, option value, cost of debt, and capital. In contrast, the growth rate is most related to the future. In addition, some startups or losing money companies do not even have historical rates. But I always estimate the growth rate first before I calculate the cost of capital for two reasons: 1. I like to finish hard work first. 2. The cost of capital can keep changing as the debt balance, stock price, and market risk premium change while you estimate the growth rate for the long term. If you value the cost of capital first, chances are you have to recalculate after you took a while to calculate the growth rate. Investment...
Post a Comment
Read more

Fiscal Year vs Calendar Year-The importance of data consistency in Valuation

When companies report financial results, they use a calendar year or decide their own "fiscal year." Apple, for example, uses a fiscal year starting in September and ending in September next year since they usually release new iPhones or have Apple meetings in September.  It is essential to make sure the data matches in valuation for consistency. To see how significant the differences can be, I will use part of my Oracle valuation to illustrate.  When valuing Oracle stock, I found that the company will have high growth whenever it has significant acquisitions and flat operating income when it does not. My judegemg is that this company growing mainly with M&A no matter how they advertise their technology. So you cannot do Oracle valuation without valuing each acquisition and calculating the return on capital.  Figure 1 and 2 below shows Oracle's M&A cost and my adjusted annual operating income. But as you can see, the M&A cost does not match the active gro...
Post a Comment
Read more

General Electric Pension Fund Valuation

  GE pension fund (This is part of my GE stock valuation)         Pension funds are pools of money contributed by employers or both employers and employees to provide retirement income. The major types of pension funds are Defined Benefit Plans and Defined contribution plans. Employers promise to pay employees a specific amount of retirement income in the Defined benefit plans. Companies contribute assets to pension funds during employees' working time, expecting the fund to generate returns to cover pension payments after they retire. In Defined Contributions Plan like 401k, employees decide how much income to contribute(with a limit), and the employers will match it.      Estimating pension funds requires us to evaluate the company's business nature, stage of life cycles, and management. Young losing money startups or high growth companies will have lower pension income rates. These companies usually keep employees with stock options to use...
Post a Comment
Read more