The popular retailer has a lot going for it, but the stock has become extremely expensive.
The stock of Costco Wholesale (COST -0.07%) has had an incredible market-beating run over the past few decades. It’s really a no-brainer buy, with all sorts of positive qualities, and it should have lots more room to grow. However, it’s trading close to its highest valuation ever. Is now the worst time to buy?
Why Costco stock is a no-brainer to own
Costco has a membership model that yields loyalty from shoppers who want to get the most bang for their buck. At $60 annually, it’s a win-win for Costco and its members.
There are reviews all over the internet explaining how much members need to spend to make a membership worthwhile, and the bottom line is, members can save well more than the amount of the annual membership.
Plenty of members keep making the jump to the next level and spend $120 for the executive membership, which comes with an extra card and other perks like 2% back in travel rewards. Costco marks down products with low margins to cover costs and keep prices as low as possible, and essentially makes its money from the membership fees.
These fees continue to increase despite the pressured economy. Costco’s shoppers are renewing at high rates, and more are signing on. In the 2024 fiscal third quarter (ended May 12), membership fees increased 7.6% to $1.1 billion. Renewal rates were 93% in the U.S. and Canada, up a drop from last quarter, and 90.5% globally.
Sales increased 9.1% year over year in the third quarter. That’s a big victory for Costco, which began to report sales declines when high inflation hit and shoppers cut spending.
Even though Costco, with its discounted prices, is by nature resistant to inflation, it felt the impact of customers cutting back on expensive items like appliances. You can see this play out in the third-quarter sales breakdown. Traffic increased 6.1% while the average transaction was up only 0.5%.
Even though shoppers are still feeling the effects of inflation, management said that the merchandising team is focused on finding quality items that resonate with Costco’s consumer base, lifting results. In the third quarter, earning per share came in at $3.78, up from $2.93 last year.
Costco recently got a new CEO and chief financial officer, but it’s the type of company where that barely gets noticed because it operates so well. So far, the transition has been seamless.
A long growth runway
Many companies as big as Costco — or bigger — have reached a certain level of saturation, making it harder to build on the existing business. But Costco expands at a slow pace and sees the opportunity for plenty of new stores, especially internationally.
It plans to open 30 stores in fiscal 2024, including 12 more by the end of the year. There is still room to expand in the U.S. It opened two new U.S. stores in the third quarter, another one since, and plans to open nine more in 2024. The company recently opened its seventh store in China, where there’s a huge opportunity, and it’s opening in other countries like Japan and South Korea.
Management’s long-term plan is to open about 30 stores annually, and even over several more years, it will still be a relatively “small” operation in terms of stores compared to most large retailers.
Why it could be the worst time to buy
So what’s the catch? Costco stock’s valuation has ballooned over the past few years. The company reported phenomenal growth early in the pandemic, and investors took notice. Costco stock has always been reliable and popular, but investors hit the accelerator, and shares have gained 220% over the past five years.
That has outpaced earnings growth, leading to valuation expansion. The stock is trading at a hefty 53 times trailing-12-month earnings. That’s high-growth territory, but Costco’s financials don’t reflect even double-digit revenue increases.
How should investors play this? It’s not the best entry point for a new shareholder, and you can wait for a pullback. Costco can’t afford to make mistakes at this valuation, and if it does, the price should dip.
But you can’t time the market. The company does usually perform flawlessly, which is why it gets the premium valuation. If you see Costco’s long-term potential and have a long time horizon, you can buy the stock today and ignore bumps along your journey. This is a good opportunity to try dollar-cost averaging, where you start a with a smaller position today and add to it steadily over time.
