Any way you slice it, Costco (COST +0.17%) has been doing great. The membership-only big-box retailer was considered an essential business during the coronavirus pandemic and was allowed to stay open. Sales and memberships surged as a result.
Impressively, Costco has sustained that pandemic-fueled momentum and even built on it two years later. The market has noticed, and Costco's stock price is up 68% in the last year and 134% in the previous three years.
These strong returns have some investors asking if Costco's stock is now too expensive? Let's take a closer look at the company right now and see if we can find an answer.
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Costco earns customer loyalty with great value
Costco is in a unique sector of retailing as its customers must buy a membership to shop at its stores. It boasts 63.4 million paying member households as of Feb. 13. That total was up by 900,000 from just 12 weeks earlier. Costco offers two membership tiers: executive and standard. The executive membership costs $120 per year and includes a perk of 2% cashback on all spending done at Costco stores. The standard membership is $60 per year.
Folks are willing to pay for access because of Costco's excellent value. Evidence for this customer value can be inferred from Costco's thin and consistent operating profit margin. The metric has stayed in the narrow range between 2.8% and 3.4% in the last decade, despite annual revenue surging by nearly $100 billion over that same time. Costco offers better value to customers instead of using efficiencies in scale to expand profit margins.
Costco may not show expanding profit margins, but it makes it up by expanding absolute profits. For instance, operating income grew from $2.7 billion in 2012 to $6.7 billion in 2021. As a result, customers show Costco their loyalty by renewing membership at a roughly 90% rate.
Moreover, Costco has an excellent opportunity to raise membership fees. In addition to delivering exceptional value to customers, one of its rivals, Amazon, recently raised the price on a Prime subscription. The price of Amazon Prime is now $14.99 monthly or $139.99 annually. Interestingly, that puts both tiers of a Costco membership below that of Amazon Prime. While some households purchase both subscriptions, many choose one or the other, and price is one of the primary considerations.
NASDAQ: COST
Key Data Points
Costco stock is on the expensive side
Costco is unquestionably an excellent business with excellent prospects. However, that may already be priced into the stock. After surging last year, Costco stock is selling at a price-to-earnings ratio of 44.7 and a price-to-free-cash-flow ratio of 40.9. That is near the higher end of the average it has sold for in the last five years.
According to the same metrics, Costco stock is pricier than its brick-and-mortar peers. Investors interested in starting a position in Costco would be prudent to wait for a pullback in the share price before purchasing. Equivalently, if the stock price stays flat and earnings and cash flow improve, it could provide a better value to investors.
