Costco Wholesale (NASDAQ: COST) is not only a consumer favorite, but a top choice among the investment community as well. Shares of the warehouse club operator have risen 595% in the past decade. Including dividends, the total return is an exceptional 752% during that same period of time.
That type of magnificent performance can draw in new investors to this retail stock, which continues to climb higher and now trades in record territory. Before you rush to buy Costco, here are three things you need to know.
1. Memberships matter
On the surface, Costco looks like a typical retailer that sells merchandise in its stores to consumers. However, a key factor to the company's success is its memberships. People must pay annual fees in order to be able to shop at Costco warehouse locations.
In fiscal 2024 (ended Sept. 1), the business generated $4.8 billion in membership fee income, up 5.4% year over year. Given that the vast majority of Costco's expenses are tied up in merchandising and corporate overhead costs, it's not hard to figure out that the memberships create a high-margin revenue stream for the business.
I wouldn't be surprised if nearly all of membership revenue flows to the bottom line. Not only that, but this is predictable and recurring in nature.
Customers find tremendous value in being a Costco member, as evidenced by the program's pricing power. Before the leadership team raised annual dues in September, Costco increased membership costs in 2017 and 2011. Despite higher fees for shoppers, the company's membership count keeps expanding, now at 76.2 million households.
This setup also drives repeat purchase behavior and customer loyalty. This certainly plays into Costco's ability to report steady same-store sales growth over time, which is what any retailer wants.
2. Scale advantages
During fiscal 2024, Costco raked in a whopping $249.6 billion in net sales. This makes it the third biggest retailer on the planet, behind only Walmart and Amazon. This scale gives Costco a durable competitive advantage.
Costco's warehouses carry on average 4,000 different stock-keeping units, well below the 30,000 or so that rival supermarkets sell. The result is that Costco is buying large quantities of a limited number of goods, resulting in incredible negotiating leverage with its base of suppliers.
By obtaining favorable pricing on merchandise from vendors, Costco is constantly able to offer shoppers low prices. Costco typically marks up the price of its merchandise by 11%. This is lower than other big-box chains. That can lead to higher net sales over time, which gives Costco even more bargaining power in a positive feedback loop.
3. Costco's valuation
Shares of Costco have absolutely trounced the broader S&P 500 in the past decade. Part of the reason for this outperformance is consistently solid financial results, with revenue and net income rising over time.
However, it's safe to say that the stock's valuation has gotten stretched. As of this writing, shares trade at a nosebleed price-to-earnings (P/E) ratio of 60. Throughout its entire history as a public company, which spans 40 years, the stock has never been more expensive than it is today. That's a clear indication of the market's extreme bullishness toward Costco.
Paying the P/E multiple might make sense if the company were about to register a growth spurt. But because this is a very mature enterprise, that's just not the case. Wall Street analysts see Costco's earnings per share rising at a compound annual rate of 11% over the next three years.
This is a fantastic company that has staying power. However, the valuation is the single most important reason that investors should avoid buying Costco stock right now.
Should you invest $1,000 in Costco Wholesale right now?
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Costco Wholesale, and Walmart. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
