Billionaires sell Costco. These 2 retail stocks are better buys.

Costco Wholesale (COST -1.75%) was one of the best performing stocks in the retail sector.

Shares of the member-based warehouse chain have risen more than 600% over the past decade, and the company continues to expand both through new stores in the U.S. and by increasing same-store sales and expanding its e-commerce business.

However, despite this success, there’s a good argument to be made that Costco is now overvalued. The stock trades at a price-to-earnings (P/E) ratio of 56, roughly double the S&P 500 index.

You don’t have to take my opinion on the rating. Top billionaire investors sold shares in the second quarter. That includes Ray Dalio’s Bridgewater Associates, which sold 94,000 Costco shares in the second quarter, worth nearly $80 million at the time.

Meanwhile, Ken Griffin’s Citadel Capital shed 124,000 shares, or about $100 million. Although Costco’s business looks strong, it’s likely that the two hedge funds concluded that its valuation was stretched.

If you’re considering chasing them from Costco, here are two retail stocks worth a spin.

Image source: Costco.

1. Home Depot

Home Depot (HD 0.71%) is the nation’s largest home improvement retailer.

While Costco shares have continued to rise since the pandemic, Home Depot has struggled with a slowing housing market, and the stock is still trading below its 2021 all-time high.

Still, Home Depot looks well positioned to move higher from here. First, the Federal Reserve kicked off its rate-cutting cycle by cutting the benchmark federal funds rate by 50 basis points last week.

Lower interest rates should help reignite the housing market, lower mortgage rates and monthly payments, and ease the lock-in effect of low mortgage rates. It will also lower rates on home equity loans and home equity lines of credit (HELOCs), encouraging renovations and other home improvement projects.

Home Depot is also poised to capitalize on the recovery thanks to its acquisition earlier this year of SRS Distribution, a leading building materials distributor. This deal helps vertically integrate Home Depot further downstream, closer to its professional customers and expands its addressable market by about $50 billion.

Shares of Home Depot now trade at a P/E ratio of 27. That might look expensive, but its earnings growth should rebound as the housing market recovers.

2. Target

Aim (TGT -0.51%) has struggled lately as well, but for different reasons than Home Depot.

Primarily a discretionary retailer, Target has been hit by slowing consumer spending as well as internal issues like theft, but the company appears to be overcoming them now and the business is moving in the right direction.

Meanwhile, inflation now appears to be under control and lower interest rates should also encourage consumer spending.

Target’s recent challenges also prompted a sharp rebound in profits, according to its second-quarter results. Gross margin rose to 28.9% from 27% in the year-ago quarter due to improved costs, favorable category mix and other factors.

This improvement in gross margin resulted in making a significant difference to the bottom line as operating margin improved from 4.8% to 6.4%. In other words, if the company can continue to make significant improvements in gross margin, profits could jump from here.

Like Costco, Target continues to open new stores, and the company enjoys a number of competitive advantages, including its multi-category business model, store-by-store fulfillment of online orders and its onboard pickup program.

Target is a stronger business than its recent performance has indicated and looks like a good buy at a P/E ratio of 16. Analysts also expect similar earnings growth next year from Target and Costco, pointing to Target showing like a steal compared to the much more expensive costco.