The Valuation Trap: Great Companies Are Not Always Good Investments - Costco vs Palantir

Great companies and good investments are different things. Through the cases of Costco and Palantir, we explore the importance of valuation.

Costco: Perfect Business, Excessive Price

Costco is undoubtedly an excellent company. The membership warehouse model is a unique business that simultaneously provides customer loyalty and stable revenue.

Costco Business Strengths

90%+ Membership Renewal Rate: Renewal rates exceed 92% in the US and 90% globally. This means customers view Costco as an essential service, not just a retailer.

Stable Revenue Structure: Most of Costco profits come from membership fees. The unique model sells products at near cost to maximize customer satisfaction and generates profits through membership fees. This ensures stable revenue despite economic fluctuations.

Strong Brand: The Kirkland Signature private label is highly rated for both quality and price, improving profitability through high-margin products.

The Problem is Valuation

Despite all these advantages, Costco stock currently receives a sell rating. The reason is simple: it is too expensive.

P/E 55x: Current P/E ratio reaches 55x, unusually high for a retail company. Compared to Walmart at P/E 30x and Target at 15x, the premium is evident.

Overvalued Relative to Growth: Revenue growth is around 7-9% annually. While excellent, it is insufficient to justify P/E 55x. Typically, a PEG ratio below 1 indicates fair pricing, but Costco PEG exceeds 6.

Margin Improvement Limits: Costco intentionally maintains low margins as part of its business model. Unable to suddenly increase margins significantly, profit growth is limited to similar rates as revenue growth.

Investment Strategy: Good Company, Bad Timing

While Costco is a company worth holding forever, it is too expensive to buy at current prices. A 20-30% correction would create a good entry opportunity, but at current levels, selling or watching is appropriate.

Palantir: Extreme Valuation on AI Theme

Palantir is a data analytics and AI platform company whose stock surged with the AI boom. However, most of the price increase stems from valuation expansion rather than performance improvement.

Palantir Business

Government Contract Dependence: About 55% of revenue comes from US government and allied government contracts. Provides data analytics platforms used by defense and intelligence agencies.

Commercial Expansion: Recently, commercial customers are increasing, and the AI-enhanced AIP platform is gaining attention. However, it still heavily depends on government revenue.

Revenue Growth: 2024 revenue growth is around 25%, which is solid. However, absolute revenue scale is around 2.5 billion dollars annually, small relative to market cap.

Extreme Valuation

P/S 40x+: Price-to-Sales ratio exceeds 40x, among the highest even for SaaS companies. Compared to Snowflake at P/S 10x and Datadog at 15x, it is extremely high.

Unstable Profitability: Palantir is barely profitable on a GAAP basis. While adjusted operating margin excluding stock compensation is high, actual net income is minimal.

Government Dependence Risk: Government budget cuts or contract renewal failures could severely impact revenue. Commercial expansion is needed, but faces competition from Snowflake, Databricks, and others.

AI Theme Bubble

The main driver of Palantir stock rise is the AI theme. However, whether actual AI-related revenue growth justifies valuation expansion is questionable.

Potential Growth Slowdown: Government contracts are large but grow slowly. Commercial sector shows fast growth but still represents a small portion of total revenue, making it difficult to significantly boost overall company growth.

Intensifying Competition: The AI data platform market is highly competitive. Palantir unique competitive advantage is unclear.

Investment Strategy: Extreme Valuation, Sell

P/S 40x is difficult to justify with any growth rate. Even if revenue doubles over the next few years, valuation will remain high. Significant price correction is likely, and selling is appropriate at current levels.

Conclusion: Valuation Determines Returns

Costco and Palantir are from completely different industries with different business models, but share a commonality: both are excellent companies but currently too expensive.

Good Company ≠ Good Investment: Even the best company becomes a bad investment if you pay excessive prices. Conversely, even mediocre companies can generate good returns if bought cheaply.

Importance of Patience: If you find a good company, patience is needed to wait for the right price. Even if you cannot buy now, opportunities will come.

In investing, what you buy is as important as how much you pay.