Costco Wholesale (COST 0.15%) has an impressive record behind it, with the business growing strongly for years and the stock price rising along with it. At this point, share prices have soared over 600% in just 10 years compared to a far less impressive 170% gain for the S&P 500 index.
All that growth has some investors wondering if perhaps they have missed their opportunity to take a ride. Is this rocket ship heading for an even higher orbit?
What does Costco do?
Before looking at Costco's stock, it is important to understand what this business does. Unlike most retailers, Costco is a warehouse club operation, which means that customers pay an annual membership fee for the privilege of shopping at Costco's warehouses. Membership fees make up around 2% of Costco's overall revenue, but because they aren't expensive for Costco to manage, they generate roughly 50% of its operating income.
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That high-margin revenue source changes the math dramatically for Costco. It gives the company the leeway to focus first and foremost on ensuring it has happy customers. It allows Costco to offer the lowest prices possible (despite the depressing impact that will have on margins) and still treat staff well so that customers have a good experience when they shop. The membership fees are a generally stable annuity-like income stream for management to rely on thanks to the roughly 90% global renewable rate of the members.
The company's efforts to expand by opening new locations is clearly about boosting revenue, but it is also about increasing its membership numbers (and maintaining that stable income stream). So far, Costco has used this business model to great effect, with revenue more than doubling over the past decade. When compared to the broader retail industry, Costco is a very well-run company.
Costco had a good run and now has a steep price
An investment issue this creates is that Wall Street is fully aware of the long-term success Costco has achieved. It's why the stock is up so much. However, new investors concerned about valuation might be hesitant to buy in. Some numbers may help illustrate this.
Costco's price-to-sales ratio is around 1.5 today compared to a five-year average of roughly 1. The price-to-earnings (P/E) ratio is just over 50 compared to a longer-term average of about 40. The price-to-book value ratio is 17 versus the five-year average of 10.5. And the price-to-cash flow ratio is 35 versus the five-year average of roughly 25. To sum all of that up, Costco is far from cheap right now. In fact, it's trading near its highest valuation level in nearly 30 years.
COST PE Ratio data by YCharts
To be fair, Costco stock is almost always on the expensive side. And growth stocks can be expensive for years on end. The real concern with valuation at this point is that Costco is significantly more expensive than usual. Using P/E as an example, Costco's current P/E is near the highest levels it has ever been. The P/E was only higher toward the end of the 1990s during the lead-up to the dot-com bust.
This lofty valuation comes after a notable stock-price run that started in early 2023. At this point, it seems hard to justify a purchase, even for those who are willing to pay up for good companies.
Probably better to wait on Costco
Costco has a very long record of success behind it, but paying too much for a good company can turn it into a bad investment. After a very strong stock-price run, most investors should heed the warning signaled by near-record valuation levels. Costco is a great company to put on your wish list today, but it may not be worth buying right now. And if you still choose to buy it, just go in knowing you are paying a premium price.
