Stock splits have been taking up much real estate in the business section of news reports lately. Whether stock splits actually add any value for shareholders is debatable, but they're popular enough that companies keep doing them.
One company that hasn't announced any stock split plans is Costco Wholesale (COST -0.46%). However, there are reasons that might be coming soon, and it might be good news for investors. Here's why.
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Too expensive for many tastes
Costco stock typically trades at a higher premium than what might be called "comparable" stocks, such as BJ's Wholesale Club, Walmart, and Target.
COST PE Ratio data by YCharts
The reason I put the word "comparable" in quotation marks is that there is a reason Costco stock trades at a premium to its peers, which essentially means that they may not quite be comparable.
Costco stands apart from its peers most notably because of its fee-based model. People pay for the privilege of shopping in Costco's warehouses, which means two things. One, the company has guaranteed annual revenue from new and recurring customers. This allows it to offer rock-bottom prices on its products, driving high volume, sales, and income, despite razor-thin margins. Two, it has excellent cash flow, because money's coming in before it has to go out. Membership fee alone came in at nearly $1 billion in the 2022 second quarter (ended Feb. 13), almost 10% higher year over year.
BJ's has a similar model (as does Walmart's Sam's Club), but a much longer cash conversion cycle, or how long it takes to convert cash from inventory into cash from sales. More plainly, it recoups its money spent more quickly -- so much more that the current number is actually negative, at -0.774, meaning the money's converted before it makes a sale. Contrast that with BJ's, a much smaller company with less leverage, whose cash conversion cycle is 8, meaning it takes eight days to turn inventory into sales.
Resetting the valuation
Costco's price-to-earnings ratio has also increased substantially over the past 10 years.
COST PE Ratio data by YCharts
Sales increased almost 13% over the trailing 12 months, and net income increased 17% over the same period. But the stock price increased much more -- 40%. That's great news for shareholders, but it means that the stock has become quite expensive. However, this is not a record PE ratio. It was even higher, more than 50, in 1999, right before the company split its stock in a 2-for-1 split in January 2000. It also had what was at the time a record PE ratio before it split its stock in 1991.
There are many other factors that determine how a stock's price fluctuates and affects its valuation. Certainly management was considering many of them before it made previous decisions to split the stock. However, it's interesting to note historically that a high valuation has preceded this decision on two occasions, and although there was an immediate increase in valuation based on investor enthusiasm, valuation significantly decreased after the split. Since the most recent stock split in 2000, Costco's PE ratio has more or less remained constant, staying below 30 for 15 years and around 30 for the next five years, until the pandemic pushed it higher.
Does it matter?
Not really. The most effective way to grow your money is to start early and keep long-term goals. Stock split or not, Costco has ample opportunities and a proven track record of managing its business. However, for those concerned about the current high valuation, a stock split might be coming soon, and a lowered valuation might come right after.
