Costco: Buy, Sell, or Hold?
Costco Wholesale (NASDAQ: COST) traces its roots back to the mid-1970s when it opened its first warehouse. It has since evolved and become a popular place for members to shop. The business has done incredibly well, and shareholders have been amply rewarded. Over the last 10 years, its shares gained 588%, easily trouncing the S&P 500's 184% increase.
While Costco has been a very successful company, retailers can't rely on their past or their reputation. Bankruptcy court is filled with once-prominent franchises such as Toys R Us and Sears. That's why it's important to understand the underlying business. Does Costco still offer an attractive investment opportunity?
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Simple but effective
Costco operates a simple business, and management executes very well. It charges members fees to shop at its warehouses. This has clear benefits to members as it offers a wide range of high-quality goods and services at attractive unit prices by buying large quantities and often selling them in bulk.
One of the best ways to measure the effectiveness of its value proposition is to look at its retention rate. Costco consistently has around a 90% renewal rate, including 90.5% in the fiscal second quarter (ended Feb. 18).
It also continues to add new members. Paid members were 73.4 million at the end of the most recent period, up from 71 million at year end. Clearly, Costco's simple value proposition has been working.
Growth prospects
The company also has been growing its number of warehouses, adding more than 20 a year, including 23 in fiscal 2023. It currently has 875 warehouses. More than two-thirds are in the United States, but it also has international locations. The company plans to open about 28 locations domestically and internationally this year.
While the early days of the pandemic held back new openings, management has accelerated plans. And with the business doing well, this makes sense.
In the most recent quarter, operating income grew 8.4% to $2.1 billion. The company has held off raising membership fees, a good way to maintain loyalty among customers feeling the pinch from higher inflation. When it decides to implement an increase, I would expect little pushback from members given that the last fee hike was in 2017. That will likely boost profitability.
The decision
With Costco executing so well over the years, the market expects this to continue. But no one would call the shares a bargain. The stock has a price-to-earnings (P/E) ratio of 52, an increase from under 40 a year ago. The current multiple is nearly double the S&P 500's P/E of 28.
It's still a strong company with growth prospects, and profitability doesn't show any signs of slowing. While it would be nice if the shares sold at a less expensive valuation, that's not the reality.
But if you feel nervous about the valuation, you can mitigate the impact by dollar-cost averaging. Investing a set dollar amount at regular periods (e.g., quarterly) allows you to buy more shares when the price dips.
If you go that route, the key is to get started and remain disciplined in regularly buying the shares. After some time, you will own a nice amount of shares in this wonderful company.
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Lawrence Rothman, CFA has positions in Costco Wholesale. The Motley Fool has positions in and recommends Costco Wholesale. The Motley Fool has a disclosure policy.
