Costco Wholesale (NASDAQ: COST) has emerged as one of the most successful and admired retail companies. Its approach of selling high-quality goods in bulk at discounted prices continues to draw increasing sales, new warehouse openings, and membership renewals.
This success has come with one unfortunate consequence for those who do not hold shares in the retail stock: an expensive valuation. With its price-to-earnings ratio at 52, its success may not quite justify its stock price. Unfortunately, investors looking for a pullback to buy are unlikely to get that discounted price.
Costco's profit model
Costco drives the majority of its profits from membership revenue. It usually sells its goods for little more than the cost of goods sold and overhead expenses, meaning it makes very little money from individual sales.
However, the company's Gold Star membership, currently $60 per year in the U.S., is pure profit for the company. On Sept. 1, this will increase to $65 per year, its first price hike since 2017. This is likely going to give its revenue and net income a one-time boost given the modesty of the increase and its 93% renewal rate in the latest quarter.
Additionally, the company has actively cracked down on membership sharing. This means that those who had benefited from sharing in the past will now have to buy separate memberships to continue shopping at Costco.
It may have taken this idea from an unrelated business. Last year, streaming giant Netflix cracked down on shared accounts, and it credits an increase in memberships to that move. This action will likely also help Costco.
Still, the effects of the increased membership fees will not appear in the financial statements for the fiscal fourth quarter, which ends this month. This means investors will have to wait until the following quarter's results in November to know the effects of the increase.
Effects on Costco
Also, that increase is the only obvious catalyst for higher profits, and it is unclear if it will help Costco stock. As mentioned before, its P/E ratio has risen to 52. Until recently, the earnings multiple had not reached a high since the late 1990s, leaving investors to wonder how much further its multiple can expand.
Moreover, so elevated is its P/E ratio that it is now higher than that of Amazon, which benefits from a cloud computing arm and other profitable businesses outside of retailing. In contrast, all of Costco's revenue comes from retailing and membership sales. In the first nine months of fiscal 2024 (ended May 12), overall sales grew by only 5%. During that time, its net income was $5 billion, 21% higher compared to the year-ago period.
Also, Costco earned about $3.3 billion in revenue from membership sales, more than the $3 billion in the same period the previous year. This implies it has made more from selling goods.
Still, Costco's success has hinged on low prices, so it is unclear how much the company can increase its prices without hurting sales volumes. Additionally, since membership price increases and the crackdown on sharing are one-time events, their further effect on growth is not apparent.
Moving forward with Costco stock
At current levels, investors need to treat Costco as a hold. Indeed, Costco remains a stable business, and the aforementioned membership price increase and crackdown on sharing should lead to a significant increase in profits.
Unfortunately, both of these moves are one-time events. Moreover, Costco has reached its highest P/E in over 20 years and is now a more expensive stock than Amazon -- which has more options for growth. That high multiple decreases the likelihood the membership increase will boost Costco stock. It also prices it at a level too expensive for new buyers despite the strength of its underlying business.
Should you invest $1,000 in Costco Wholesale right now?
Before you buy stock in Costco Wholesale, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and Costco Wholesale wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Consider when Nvidia made this list on April 15, 2005... if you invested $1,000 at the time of our recommendation, you’d have $668,029!*
Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. The Stock Advisor service has more than quadrupled the return of S&P 500 since 2002*.
*Stock Advisor returns as of August 12, 2024
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Will Healy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Costco Wholesale, and Netflix. 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.
