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This Scenario Will Cause Me to Buy Costco Stock

By Parkev Tatevosian, CFA – Aug 31, 2021 at 9:30AM

Key Points

  • Costco is trading at a forward price-to-earnings ratio of 42.
  • The company boasts over 60 million paying households as members.
  • Costco stock is up over 18% this year.

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The company piqued my interest with its excellent performance during the multi-faceted challenges of the pandemic.

Costco (COST -0.55%) is demonstrating excellent operating performance during the pandemic. Revenue surged at the onset when non-essential retailers closed their doors and Costco remained open. Consumers had fewer places to spend their money, so those deemed essential stores benefitted from an increase in shoppers. 

The company has been able to maintain that momentum even as economies are reopening. Its recent performance under strenuous conditions and its history of satisfying customers earned Costco a spot on my watch list. 

A shopper inside a Costco store.

Costco stock is trading at a forward price-to-earnings ratio of 42. Image source: Getty Images.

Here's what I am waiting for 

It's important to note that Costco is a membership store. To gain access to shop at its warehouses, customers must pay an annual fee of either $60 for the basic membership tier or $120 for the executive tier. The latter comes with 2% cash back on your spending at Costco, which allows a consumer to earn back the membership fee after $6,000 spent during the membership year.

Historically, Costco raises prices on memberships about every five years. That time is approaching again, as it last raised fees in 2017. As of its most recent quarter, Costco boasted 60.6 million paying households. A $5 fee increase on all members would result in an additional $300 million in revenue, assuming very few membership cancellations. Considering Costco's renewal rate of 91%, that's not a wild assumption.

Nearly all of the company's membership revenue flows to the bottom line because it does not cost incremental dollars to implement a price hike. Of course, Costco might need to send out a notice in the mail and field a few questions, but in the grand scheme of things, it's a minor blip on the expense side.  

To put that figure into context, in fiscal 2020, Costco earned an operating profit of $5.4 billion. So the $300 million from the membership fee increase could boost its operating profit by 5.5% annually.

There's a catch

I am probably not the only investor looking for Costco to raise membership fees. Others who follow the stock are likely also aware that a fee hike is approaching. Therefore, when Costco eventually makes the announcement, Costco's stock price might quickly jump in response. In that scenario, I would not buy the stock. 

The stock is already running pretty fast and is up 18.5% year to date. The rise has it trading at a forward price-to-earnings ratio of 42, which is the highest it has traded at since at least January 2020. Some investors may be buying the stock in anticipation of the membership price increase. Some are buying it because of the company's excellent performance during the pandemic and its solid long-term prospects.

In any case, the stock is already a little pricey, but if Costco raises membership prices and the stock does not rise too much in response, I will likely add a position in this excellent business. If you are anything like me, you should also consider adding Costco to your watch list. 

Parkev Tatevosian has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale. The Motley Fool has a disclosure policy.

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