Should you buy shares of this million-dollar company instead of Wholesale Costco?

Most people find it easier to follow the crowd than to go against what everyone else is doing. This is why some stocks tend to trade in one direction (usually up) for long periods of time, depending on how enthusiastic the broader investment community is feeling at any given time. For Costco wholesale (EXPENSES 1.00%)This follow-the-crowd mentality has worked well for several years. The crowd’s enthusiasm has helped the stock outperform the broader stock market, returning 222% over the past five years (up from 102% in the previous period). S&P 500 Index).

It is in such cases contrarian investing sometimes comes into play. Instead, the investor is looking for opportunities where the popularity of an investment choice in the broader market has led people to sharply underprice certain other securities. Now may be the ideal time for contrarian investors to consider buying Hershey (HSY -0.14%). Here’s why.

The air around Costco is getting thin

Costco has an impeccable reputation as one of the best retailers in the world, and it’s well deserved. The company has a cult following among some of its members and is known for its wide selection and low prices in stores. Customers must pay membership fees to shop at the company’s stores, as Costco does. receives most of its profits.

Good companies don’t often go up for sale, and Costco is no exception. Over the past decade, shares have traded at an average price/earnings ratio (P/E) 35, which is a huge premium to the wider market. However, the stock continues to deliver stellar investment returns.

But as you can see below, Costco’s 2024 valuation has broken through the glass ceiling and is stuck in the clouds:

COST PE ratio data on YCharts

As good as Costco is, at some point it will likely revert to the mean and potentially drag the stock price down. Over the long term, Costco’s earnings are expected to grow at about 9% annually. It will be difficult to justify such a high valuation without further growth.

Hershey is a million-dollar company facing difficult times.

Hershey is a completely different business than Costco (although many Hershey products are sold in Costco stores. The company is one of the leading candy companies in the United States with beloved brands such as Hershey’s, Reese’s, Twizzlers, KitKat, Jolly Rancher and others. The company also expanded into the snack segment and now owns popcorn and pretzel brands such as Pirate’s Booty, SkinnyPop and Dot’s.

The strength of the brand has allowed Hershey to achieve high return on invested capital (ROIC)averaging over 17% over the past three decades and has gradually increased over time. You wouldn’t mistake Hershey for a growth stock, but its steady growth is good enough because the business has a very high return on investment. Hershey is a cash cow that can simultaneously buy back shares, pay and receive dividends, and develop and acquire new products.

Result? Generational wealth. Over the past five decades, Hershey has generated nearly 44,000% returns, making the company a bona fide millionaire maker for long-term shareholders.

Unfortunately, the company is currently struggling with serious difficulties. Cocoa beans are the main ingredient in chocolate. Bad weather and disease have decimated cocoa crops over the past 18 months, sending prices of the commodity to record highs. This forced companies like Hershey’s to raise prices to try to offset some of the extra costs, which in turn hurt sales.

Hershey’s earnings were growing 8% to 10% annually, but a disruption in cocoa farming has derailed the company’s growth forecasts and dampened sentiment for the stock:

HSY EPS LT Growth Estimate data on YCharts

Why now is the time to buy

Hershey has been hit so hard that its stock is showing rare valuation signals. The company’s dividend yield reached 3% for only the third time. The stock has averaged a P/E ratio of 25 over its history, but today trades at around 20 times earnings. Remember, Hershey’s business is struggling, so earnings are likely a bit understated. The last time Hershey’s dividend yield was this high, the stock was trading near a P/E ratio of 18, which has happened only a few times in the last quarter century:

Dividend yield on HSY data on YCharts

Unfortunately, Hershey probably won’t solve its short-term problems overnight. Industry experts believe cocoa prices could remain high until next fall, so keep that in mind. But Hershey looks like a broken stock, not a broken company. Hershey stock has enjoyed a stellar reputation and premium valuation for decades, and there’s no obvious reason why it couldn’t continue to do so once Hershey shows signs of turning around its business.

These are the opportunities you are looking for as a long-term investor. Hershey may not immediately make you look like a genius, but there’s a good chance that investors buying Costco stock right now will look back in five years and wish they had bought Hershey instead.