Better Buy: Costco Wholesale Corporation vs. Wal-Mart

In April, I compared Costco Wholesale (COST -0.61%) to Whole Foods, dubbing the organic retailer a better buy than the wholesale giant. But how does Costco stock look next to Wal-Mart (WMT 0.38%) -- the parent company of Costco's biggest competition? Is Costco still showing Sam's Club how it's done? And, more importantly for investors, is Costco still a better stock than Wal-Mart?

Growth

While Costco's overall business saw sales increase at a faster rate than Wal-Mart's in its most recent quarter, its lead is even more pronounced when directly comparing Costco's wholesale business to Wal-Mart's Sam's Club business. For instance, excluding Costco's fuel business and adjusting for currency changes, Costco same-store sales were up 3% in its most recent quarter. In the same period, Sam's Club's same-store sales were up just 0.1%. 

Further, when looking at the two companies side-by-side during the trailing-12-month period, Costco's growth meaningfully outperforms Wal-Mart's. Costco's sales during this period are up 1.4% and Wal-Mart's are down 0.5%.

And for investors interested in how the two companies have faired during a broader period, consider their compound average annualized growth rate for EPS during the past five years; Costco, thanks to its more efficient operation and management's more effective allocation of capital, crushed Wal-Mart's EPS growth of 1.8% with a rate of 12.9%.

Valuation

With Costco and Wal-Mart stock's moving in different directions recently, it's particularly a good time to compare their valuations. During the past six months, Costco has soared nearly 18% and Wal-Mart is down about 8%. Could Wal-Mart's lower stock price make up for its obviously worse growth prospects?

Costco.

There are several ways to compare the two stocks when it comes to valuation. Perhaps the most useful are price-to-earnings and price-to-sales. Costco, trading at 28.7 times earnings, is clearly trading at a premium to Wal-Mart. Comparatively, Wal-Mart has a P/E ratio of just 15.7. Costco's premium valuation isn't as obvious when looking at the two companies' price-to-sales ratios, since both companies sport a price-to-sales ratio of 0.5. But since Wal-Mart's sales are technically more valuable than Costco's since Wal-Mart's profits are equal to 3% of sales and Costco's are equal to just 2% of sales, even this metric highlights Costco's premium valuation after careful examination.

What should investors make of these valuations?

While Wal-Mart's stock trades at a much more conservative valuation than Costco, it still assumes the company can return to single-digit annualized EPS growth over the long haul. In my opinion, this is a particularly dangerous assumption to make as Amazon continues to make inroads on Wal-Mart's addressable market. It's difficult to conclude, therefore, that Wal-Mart lives up to its valuation.

Meanwhile, while Costco does trade at a much higher premium to its profits, the company's consistent history of one-upping Sam's Club, its dominating scale, and its wholesale emphasis, set it apart as a company that can sustain a competitive advantage and continue growing for the long haul.

I'd place my bets on Costco over Wal-Mart.