Should one Buy, Sell, or Maintain their Investment in Costco Shares?
When discussing robust retail businesses, investors frequently find it challenging to outshine Costco (COST dropping by 1.86%). This retail colossus appears to defy earthly laws as its stock value persists in ascending, marked by a surge of 50% over the past year.
Naturally, this situation leaves investors pondering their future steps with Costco stock. Is this momentum an indication for investors to buy, disregarding valuation concerns? Furthermore, even for existing shareholders, is there a compelling argument to remain invested or should the escalating price tag deter all investors? Given these possibilities, it would be prudent to thoroughly examine the retail sector before making decisions.
Costco's unique characteristics
Despite the fierce competition in the retail sphere, Costco boasts certain distinctive advantages. While it competes against tech titans like Amazon, which benefits from lower storage warehouse costs and additional businesses that could theoretically cover retail losses, it's important to remember that Amazon's fulfillment centers also incur overhead expenses, thereby somewhat diminishing that advantage.
Moreover, Costco capitalizes on its bulk item sales strategy to slash prices further. Furthermore, it has successfully navigated cultural hurdles that previously stymied the international expansion of competitors like Walmart and Home Depot. This has allowed Costco to expand its reach into new territories without significantly increasing its store count, even in the U.S. and 14 international markets.
In addition, Costco has cultivated a loyal customer base. Its global membership renewal rate stands at a remarkable 90%, and in the U.S., despite a recent membership price hike, 93% of Costco members opt to renew their memberships annually.
Quantifying Costco's performance
However, these benefits come with a price tag for investors. The stock's escalating popularity has driven its P/E ratio to an almost record-breaking 57, making further increases in stock value less probable. Its forward earnings multiple of 54 indicates that rising earnings may not significantly lower the P/E ratio.
Sadly, this exorbitant valuation does not appear to be justified by its financials. In the first quarter of fiscal 2025 (closing on Nov. 24), the company's total revenue increased by 8%, but its growth rate overall remains modest at 5%.
During fiscal Q1, the company reported a net income of $1.8 billion, growing by 13% due to income from non-operational sources. Nevertheless, this growth has slowed down from 17% in the previous fiscal year.
Looking ahead, analysts forecast a 7% revenue growth for the current fiscal year and the same percentage for the following 12-month period. Given the 57 P/E ratio, this growth indicates that Costco stock might not be a worthwhile investment.
Furthermore, dividends may not provide much support. Although the company consistently raises its payout, its annual payout of $4.64 per share results in a negligible dividend yield of less than 0.5%, far below the 1.2% average of the S&P 500.
In addition, while Costco had paid a $15 per share special dividend last year, regularly paying such dividends would be required to surpass the industry average, an unlikely scenario for its stakeholders. Moreover, the company's previous special dividend of $10 per share occurred in 2020, limiting its potential as an income-generating stock.
Finally, the stock is approaching levels of such magnitude that investors might want to evaluate their options. It required significantly lower valuations to prompt Berkshire Hathaway, led by Warren Buffett, to part with its long-held Costco position in 2020. While Buffett later admitted it might have been a mistake, this perhaps suggests that others might also choose to divest from the stock, potentially setting the stage for a significant correction.
In light of Costco's impressive member retention rates and international expansion, investors might be tempted to invest, despite the high P/E ratio. However, the company's modest revenue growth and low dividend yield might deter some investors, prompting them to consider the stock's potential for further value increase.
Given Costco's high valuation and the historical decision of Berkshire Hathaway to sell its Costco position, some investors might be pondering whether it's an opportune time to diversify their investing portfolio by exploring alternative options.