The Costco Conundrum: Weighing the Pros and Cons of This Retail Giant
When it comes to solid retail businesses, few can rival Costco’s impressive track record. The warehouse retailing giant’s stock has defied gravity, surging 50% over the last year despite increasingly strong arguments for its overvaluation. This leaves investors wondering how to move forward with Costco stock. Should they buy in, hoping its valuation no longer matters, or is its price so stratospheric that it’s time to stay away?
A Closer Look at Costco’s Advantages
Despite intense competition in retailing, Costco holds some distinct advantages. Its bulk sales model allows it to slash prices, making it a formidable competitor. Additionally, the company has sidestepped cultural challenges that hampered the international growth of retailers like Walmart and Home Depot. With a strong presence in 47 U.S. states and 14 countries, Costco has barely scratched the surface of its potential store growth.
Customer Loyalty: A Key Strength
Costco has fostered strong customer loyalty, with a 90% global membership renewal rate. Even after a recent membership price hike in the U.S., 93% of American Costco members chose to renew their memberships. This loyalty is a significant asset for the company.
The Price of Success: A High P/E Ratio
However, these advantages come at a cost for investors. The stock’s increasing buyer interest has taken its P/E ratio to almost an all-time high of 57, making continued increases in the stock price less likely. Its forward earnings multiple of 54 indicates that rising profits will not lower its P/E ratio significantly.
Financial Performance: Respectable but Not Outsized
In the first quarter of fiscal 2025, total revenue rose 8% year over year to $62 billion. While revenue growth is respectable, it’s not outsized. Net income grew 13% in fiscal Q1, but this has fallen from the 17% increase in fiscal 2024. Analysts forecast 7% revenue growth in the current fiscal year and the same percentage in the following 12-month period.
Dividend Yield: A Disappointment
Although Costco consistently raises its payout, its $4.64 per share annual payout amounts to a dividend yield of less than 0.5%. This is far below the 1.2% average of the S&P 500. Even the company’s special dividend of $15 per share last year is unlikely to make it an excellent income stock.
Time to Sell?
With the stock approaching levels so high that investors might want to consider selling, it’s worth noting that Warren Buffett’s team at Berkshire Hathaway closed its long-held Costco position in 2020. While Buffett later described the move as “probably a mistake,” one could argue that he was early instead of wrong. Under current conditions, investors should probably consider selling Costco stock.
A Solid Business, but Overvalued
Admittedly, Costco is one of the more solid retail operations in existence. At a lower valuation, one could make a case for holding Costco stock. However, its growth is such that its earnings multiple will not fall significantly without a considerable stock price decline, a move that seems likely if history is a guide. Moreover, the dividend is likely not enough to retain income investors. Even though Costco’s business will likely continue growing in the long term, its stock appears overdue for a significant pullback.
Leave a Reply