Costco (NASDAQ: COST) has been a huge winner for investors, with a 1,700%-plus share-price advance since the turn of the century. Factor in its dividend, and its total return soars to 2,600%! That's a truly incredible performance over a period of just under 25 years. It would be understandable if you wanted to buy Costco, but you need to know a few things first before jumping on this warehouse giant's stock.
Costco has a great foundation
Costco isn't your typical retailer because its customers pay a membership fee for the privilege of shopping at its stores. This is important because the membership fees Costco charges end up being similar to an annuity-like income stream. In the fiscal third quarter of 2024, Costco generated $1.1 billion worth of membership fee revenue. Given that there's little cost associated with that income, it made up around 50% of the company's operating income.
This gives Costco a lot of leeway regarding the prices it charges for products. Essentially, Costco can accept lower profit margins on product sales as it looks to keep its members happy because happy members renew their memberships. It is something of a virtuous cycle, with the company always looking for ways to ensure that its customers want to come back. That includes everything from strong employee relations to taking on a larger role in logistics during the coronavirus pandemic. Low prices, fully stocked shelves, and helpful employees are the goal.
Given its long-term success, this model clearly works. Not only has the stock notched huge gains, but so have sales, which are up 650% since 2000. Earnings have increased nearly 950%. Investors aren't buying Costco on a wing and a prayer; it has put up big numbers backed by a strong business model.
COST Revenue (Annual) data by YCharts
Put Costco on your wish list
Costco could help you retire a millionaire if it keeps executing at a high level, but not if you overpay for it. And that looks like it may be the case today.
For starters, Costco's stock is near all-time highs. In and of itself, this isn't a reason to run for the hills, but it does highlight that Wall Street is well aware of the company's long-term success. Furthermore, shares sport a price-to-earnings ratio (P/E) of nearly 52. That's high for any company, but it is also historically high for Costco, which has a five-year average P/E of about 40 -- and even 40 is kind of lofty.
But the really troubling thing is that the P/E ratio is -- much like the stock price -- near all-time highs. The last time the P/E ratio was as elevated as it is today was in the late 1990s, right before the turn of the century. It is entirely possible that Wall Street is correctly anticipating a huge increase in earnings from the company's current level, but it is probably more likely that investors are pricing in a huge amount of good news. Even a small business shortfall could be enough to pull the stock back to a more attractive entry point given the soaring valuation investors are assigning Costco today.
Yes, Costco is a great company, but don't rush to buy it
So could Costco and its lucrative business model be a millionaire maker? Sure, in the long run -- but you reduce the probability of that if you pay too much for the shares, and that seems like the situation today given the elevated P/E ratio.
This stock is probably best put on your wish list and not your immediate buy list. But if that P/E ever drops down to at least the five-year average, or preferably even lower, you might want to add some Costco stock to your portfolio.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale. 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.
