Shares of Costco (COST +0.45%) have rewarded investors as they've skyrocketed 234% in the past five years. And in 2024, their 31% gain (as of June 17) is easily outpacing the broader S&P 500.
Clearly, this top retail stock has been a wonderful investment in the past. But I think the business is about to make a big strategic move that can further boost its financial performance. Let's take a closer look at Costco's operations.
Asking customers to pay more
Costco runs 876 warehouses, mostly in the U.S., which sell a wide range of high-quality merchandise at extremely low prices. This doesn't sound that unique on its own. But what makes this business stand out is that it operates a membership-based business model. For $60 a year, consumers can pay for the right to shop at Costco locations.
There's been talk for a few quarters that the company will raise its membership fee, which is causing a lot of anticipation. The business has historically increased the annual dues that its customers pay once every few years. It last happened in June 2017, and before that, it occurred in November 2011. We are within the time frame when it might happen again.
Costco is a boring enterprise with operations that don't change much. But I believe the company's next big move will be to raise the membership fee.
"And by the way, it's when, not if," said CFO Richard Galanti on the Q2 2024 earnings call about the possibility of a price hike. He went on to explain that the decision is based more on feeling than using some complex decision-making process. When management believes the time is right, it will happen.
NASDAQ: COST
Key Data Points
Financial implications
Costco's main objective isn't to make the most money on the sale of goods. On average, the company typically marks up its merchandise by 11%, a much lower amount than other big-box retailers. The key is to turn over goods quickly.
The company makes sizable profits on its memberships. It raked in $1.1 billion in membership-fee income in the fiscal 2024 third quarter (ended May 12). I'd argue that this revenue source is extremely high-margin. During Q3, Costco generated $2.2 billion of operating income, with the majority likely coming from membership fees.
Therefore, whenever the company decides to raise the annual cost, say by $5 or $10, it should provide a boost to the bottom line. While it's reasonable to assume that some customers might cancel their memberships, given that Costco boasts a stellar 90.5% worldwide renewal rate, I believe the negative impacts, if any, will be minimal.
Warren Buffett, arguably the greatest capital allocator ever, has said before that he believes the mark of a high-quality business is its ability to successfully increase prices. At first, investors might not view Costco in this light. But that's because they're probably only thinking about merchandise sales. When looking at the membership dues, this company has proven in the past that it has pricing power.
Patiently waiting
With the expectation of this strategic move, some investors could be looking to add Costco to their portfolios. It's hard to deny that this is a superb business. Revenue and earnings have shown a consistent ability to grow over the years. Customer loyalty is high. And there is still a meaningful runway to open new warehouses.
However, Costco is a very expensive stock right now. It trades at a price-to-earnings ratio of 53.8. Since the start of this century, shares have never sold for a higher valuation. The best course of action is to wait until the stock is much more attractively priced.
