Costco Wholesale (COST 0.17%) stock has been an excellent investment over the past decade, rising about 530% over that time. Its steady gain over that time has significantly outpaced the broader market's 201% rise.
Over the past two years, this warehouse club retailer has been doing great business and escalating the enthusiasm from investors eager to snap up shares. That's sent Costco's valuation up and resulted in a price-to-earnings ratio of 43. Such an elevated P/E might seem reasonable in a growth stock, but it is pretty high for an established, slower-growing company. Some investors are starting to wonder if Costco's stock is getting overpriced.
Valuation is a consideration in determining whether or not to buy a stock, but it should always be evaluated in the context of a company's long-term potential. That's why you shouldn't be worried too much about Costco's elevated valuation. Let me explain.
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Costco's business is packed full of potential
Before the pandemic, Costco's quarterly sales growth was typically a high-single-digit percentage. But over the past two years, the retailer has been posting mid-teens percentage level growth. In fiscal 2022's second quarter (ended Feb. 13) Costco reported a 16% boost in sales year over year to $51 billion. In March, sales rose even higher with a 19% year-over-year increase.
At the start of the pandemic, sales rose as customers stocked up on essentials. Lately, sales are up as customers look for ways to combat inflation. Costco's rock-bottom prices are always popular, and its fee-based model drives high volume. The company's strengths become more apparent during tough economic times. One of those strengths is Costco's ability to leverage its relationships with suppliers to get merchandise customers want despite supply chain issues.
Another potential for revenue growth is Costco's still relatively small total number of warehouses. It operates 829 global stores, with 573 in the U.S., and management plans for 28 net new stores in 2022, slightly more than its typical openings. Costco takes its time opening new stores, but each warehouse averages around $25 million in annual sales.
While researching the company, I found this gem: In 2000 (and around the time of its last stock split), Costco's earnings per share (EPS) came in a penny below expectations, causing several Wall Street analysts to downgrade the stock. Since then, Costco stock has gained more than 1,500%, laughably outperforming the S&P 500. Incidentally, the stock was trading at a P/E ratio of more than 50 right before that 2000 split.
COST data by YCharts
Investor takeaway
Long-term investors know that you can't time the market. Over the past month, Costco's valuation was creeping a little too high for the average investor's tastes, but then the share price began to come down. It's just the market evening things out.
If you bought the stock a month ago, you've seen your investment decline by about 8.2%. But if you bought because you see Costco's immense potential to continue growing and capturing market share, you know not to worry. Like any stock, there will be plenty of short-term ups and downs on the path to long-term gains.
