Costco Wholesale (COST 0.17%), the world's third-largest retailer, has been a huge boost for investment portfolios. The top warehouse club operator has seen its stock price soar 217% over the past five years, more than doubling the S&P 500's total return during the same time.
Providing customers with an exceptional, one-stop shopping experience has worked wonders for Costco, a fact that has been on full display over the past couple of pandemic-fueled years. And the momentum still hasn't faded as same-store sales jumped 14.4% and diluted earnings per share increased 36.4% year over year in the company's fiscal 2022 second quarter (ended Feb. 13).
Costco's competitive strength has never been more apparent, and it's the next stock I'm going to buy.
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Scale economics shared
I think what makes Costco a truly great company is something called "scale economics shared" (SES). With trailing 12-month net revenue of $206.2 billion, the business is able to flex its bargaining power with its suppliers in order to obtain the lowest costs possible for inventory. And these savings are immediately passed on to consumers. On average, items at Costco are marked up by only 11%, significantly lower than the 25% to 50% mark-up at most retailers.
Customers must pay an annual fee of $60 for a Gold Star membership or $120 for an Executive membership to be able to shop at a Costco. But again, because prices are so low, having a Costco membership is almost a no-brainer decision. As of Feb. 13, the company had 63.4 million member households. And the renewal rate in the U.S. and Canada was a stellar 92% in the latest quarter. Membership revenue of $4 billion over the past 12 month generated the bulk of corporate profits.
This top brick-and-mortar retailer is a rare business that not only takes care of its customer base (with lower prices and a great shopping experience) but also its employees (in the form of industry-leading wages and benefits) and suppliers (with broad distribution by being on Costco's shelves). And as one of these groups benefit, they all do. This is a powerful force that has propelled the company throughout the years and will continue to going forward.
A long and successful history
As I alluded to in the introduction, Costco's stock has been a major winner for investors. This can partly be attributed to the company's five-year cumulative revenue and net income growth of 65% and 113%, respectively. What's more, thanks to continued efficiency gains, the operating margin has trended higher from 3.1% in fiscal 2016 to 3.7% in fiscal 2021.
This remarkable success has resulted in a winning investment for shareholders. This is not only from stock price appreciation but also from Costco's dividends. Since initiating a dividend in 2004, the business has increased its annual payout by 13% per year. And occasionally, management offers up a special cash dividend, with the most recent being a $10 per-share outlay in the first quarter of fiscal 2021.
Looking ahead, management is optimistic that Costco possesses ample growth opportunities. Although there are currently 829 warehouses worldwide, the company plans to open 28 net new stores this fiscal year alone. And China, which has two warehouses today, is seen as a massive opportunity for Costco in the decade ahead.
Costco's stock isn't cheap
Despite its positive qualitative characteristics, there is one issue that many investors have with Costco's stock right now -- its expensive valuation. As of April 28, Costco's price-to-earnings (P/E) ratio was slightly over 45, near the highest level in the past 10 years. This is a premium to competitors Walmart (with a P/E of 32) and Target (P/E of 17). However, as I've highlighted in this article, Costco is a superb business that most likely deserves its high multiple.
Even with the elevated valuation in mind, I'm comfortable starting a small position (1% of my portfolio) in Costco. That's because it'll allow me to learn more about the business and pay closer attention to its continued progress in the near term. And I can obviously keep adding to my position over time as my confidence in and familiarity with the company grows.
