Costco Wholesale (NASDAQ: COST) is a $370-billion-market-cap retailer that can hold its own against some of the sector’s largest players. The core business model has a lot to do with the company’s success, which makes it an attractive stock. But Costco is almost always expensive and looks particularly expensive right now.
Here’s what you need to know about Costco stock before you decide whether to buy it.
Costco’s model is strong
Costco isn’t just any retailer; it is technically a club. Customers pay an annual membership fee for the privilege of shopping at one of its stores. That has to be looked at more closely, though, to really understand how powerful a fact this ends up being.
In the fiscal third quarter of 2024, Costco’s revenue totaled $58.5 billion. Of that total, around $57.4 billion came from the sale of products from its stores. Only $1.1 billion was derived from membership fees. That makes it look like membership fees aren’t important. However, membership fees don’t come with material costs, unlike the products Costco sells. Merchandise costs in the quarter totaled nearly $51.2 billion, while running the stores (selling, general, and administrative costs) were $5.1 billion.
When you total it all out, Costco’s operating income was a little under $2.2 billion, which means that around half of the company’s operating income is attributable to membership fees. That’s an annuity-like income stream, too, which helps explain why Wall Street is so fond of Costco.
Everyone knows how good Costco is
There’s clearly a good reason to want to buy Costco, given its strong business model, but should you buy it? That is a bit more difficult to answer. Costco stock is pretty much always expensive. At the start of 2023, Costco’s price-to-earnings ratio was in line with its five-year average P/E. At that point, it was likely fairly priced, but the P/E was still in the 30s, which is fairly lofty.
Today, however, the P/E ratio hovers around 50 and is far above the five-year average of around 40. In fact, the P/E today is near the highest level in the retailer’s history. It would be hard to justify buying Costco if you were a value investor. But at that P/E level, it should be hard to justify Costco for growth investors, too.
Another comparison might help. Walmart (NYSE: WMT), one of Costco’s largest competitors, has a P/E ratio of around 30. And Walmart’s P/E is roughly in line with its five-year average P/E. Although it doesn’t operate club stores, Target (NYSE: TGT) has a P/E of roughly 17 and a five-year average P/E of about 20.
You can start to see what’s going on here. It looks like Wall Street is pricing in a huge amount of good news at Costco. And it’s far more good news than it is pricing in at some of the company’s largest peers. From this perspective, it does look like investors have missed the opportunity to buy Costco, given the recent stock advance.
Keep an eye on Costco
That said, Costco is a very well-run company and is the type of stock you should keep on your wish list just in case it sells off. You probably won’t ever find it trading at bargain-basement prices, but this is a case where it is probably worth paying full price (though not a massive premium, as seems to exist today).
If the P/E ratio comes back in line with the longer-term average P/E for any reason (even weak financial performance), you should consider revisiting Costco. But make your mind up now that you want to own it because the news will probably be bad when the opportunity to do so arrives, either because of a bear market or a temporary business setback. If you don’t plan ahead, you may miss the chance to buy this industry-leading retailer again.
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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, Target, and Walmart. The Motley Fool has a disclosure policy.
Is It Too Late to Buy Costco Stock? was originally published by The Motley Fool
