Costco Wholesale (COST 0.47%) might not be the most talked-about stock on Wall Street, but it's definitely a company that all investors should want to know. The retail juggernaut has been on an absolute tear this past year, returning 63% to its shareholders vs. the S&P 500's 8% increase over the same time period. The company's stock has been no slouch over the long run, either -- Costco shares have rewarded investors with a 291% gain over the past five years, equating to an average annualized return of 58%.
Consistent past performance is always a plus; however, as long-term investors, we should focus more on what a company is going to look like several years down the road. Costco continues to impress on the financial front, but there are several drawbacks that investors should be aware of before buying the stock. On that note, let's examine Costco's bull and bear cases to help you decide if the company is worth your investment today.
What the bulls are saying
Costco has a lot to brag about, but let's start with its exceptional financial statements. In its most recent quarter, the company generated $51.9 billion in sales and earnings per share (EPS) of $2.92, translating to 16% and 36% growth year over year, respectively. Given its colossal size, this is extremely impressive growth.
Plus, I don't think you can get much better than Costco's balance sheet. As of the second quarter of fiscal 2022, The company's $11.8 billion cash position exceeds its $9.2 billion in debt. Carrying a debt-to-equity ratio of only 46%, Costco is well-suited to weather any economic storm. And then there's cash, which Costco continues to generate with ease. In the past three years, the company's free cash flow and cash from operations have expanded at compound annual rates of 24% and 16%, respectively.
In a market that is so unpredictable today, Costco is as stable of an investment as they come. The company's membership model ensures consistent profits and paints a transparent picture for investors looking to forecast the company's future. Despite only making up 2% of total revenue in 2021, membership fees represented over 75% of net profits. And provided that Costco's member renewal rate is 91%, investors can comfortably count on the company reporting a solid bottom line.
Kirkland Signature, the company's private label, makes Costco's life easier as well. This past year, Kirkland sales eclipsed $59 billion, equal to 30% of total revenue. Think about that -- not only did Costco's private label generate three-and-a-half times more revenue than close competitor BJ's Wholesale (BJ -0.92%), it represents nearly one-third of the company's entire business. This gives Costco an immense amount of pricing power and allows it to stay committed to offering competitively low prices.
What the bears are saying
There's no doubt that the bears are talking about Costco's valuation. Costco is trading at 48 times earnings, which is extremely high compared to such peers as BJ's Wholesale, Walmart (WMT -0.03%), Kroger (KR 0.16%), and Target (TGT -0.79%). When examining the chart below, you'll notice that Costco's P/E is two times higher than the median of its close industry counterparts.
Provided that analysts are only modeling 7% and 10% average annualized growth in revenue and earnings through 2025, Costco's valuation appears lofty. Costco has historically traded at a premium relative to competition, but even so, the company's current P/E multiple is much higher than its five-year average of 36. Investors will need to decide for themselves if Costco is worth paying the price for at current levels.
What I'm saying
Costco is a tremendous company -- it's as simple as that. In my eyes, however, that doesn't make it a wise investment today. I've always felt that Costco deserves to trade at a premium relative to most of its peers. The company's membership model and pricing power have helped it establish a robust economic moat worth paying for at a higher price.
But just like many things in life, enough is enough. Costco's valuation has spun out of control this past year, and I can't justify buying the stock today. Long-term shareholders should feel comfortable with their positions, but interested buyers should probably remain on the sidelines for now. Wait until this stock experiences a pullback, and then consider buying shares.