Costco Wholesale (COST 0.84%) is one retailer that has done an excellent job grappling with rising inflation. The company has a reputation for high customer value and has had success passing along rising costs to consumers in the rare times it exercises that power. Additionally, it sells bulk-sized items, which reduces the per-unit costs to consumers, something folks are looking to capitalize on as inflation lowers their purchasing power.
Let's take a broader view of the business, consider the valuation, and determine if investors should buy Costco stock right now.
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Costco has a loyal customer base
Note that Costco operates on a membership model. Folks need to pay annual dues to gain access to shop at its warehouses. Costco offers two tiers of membership, standard and executive. The former is $60 per year. The latter is $120 and provides an additional benefit of 2% cashback on all purchases made at Costco. Interestingly, Costco has a loyal customer base that renewed its memberships at a 90% rate worldwide in the most recent quarter, which ended May 8.
As of that same date, Costco had 64.4 million paying membership households. Costco's merchandising strategy is a no-frills collection of bulk-size products at affordable prices. For instance, you will not see Costco carrying single cereal boxes. Instead, it will offer multi-packs. This lowers the cost per cereal box for consumers, but they must buy multiple packs. The model has worked to increase Costco's sales from $99 billion in 2012 to $196 billion in 2021.
As you might imagine, offering excellent value to customers means low-profit margins for Costco. Its operating profit margin hovered between 2.8% and 3.4% since 2012. However, Costco's total operating income has grown from $2.8 billion to $6.7 billion in that time. This highlights that selling products at a small margin, and a high turnover, is conducive to the bottom line.
COST Operating Margin (Annual) data by YCharts
Costco is effectively addressing rising inflation
Costco's prospects could be even better in the near term, because of rising inflation. Folks are not happy about their money losing purchasing power and could look to Costco's excellent value more urgently. Management noted that it experienced increasing costs for the items it sells but has weathered the storm skillfully so far. In its latest quarter completed in May, earnings per share rose to $3.04 from $2.75 in the same quarter of the prior year.
The company has only cautiously raised prices on products and held firm on a popular $1.50 price for a hot dog and soda combo it offers to members. It has made up for the lower gross profit margin caused by rising input costs by leveraging other fixed costs through growing sales. Costco's value proposition could increase further in consumers' eyes as other retailers raise prices while Costco hesitates.
Should you buy Costco stock now?
COST Price to Free Cash Flow data by YCharts
Costco's prospects in the near and long term are excellent. Over decades, the company has demonstrated that it is a top-tier retailer and convinced consumers of its value proposition. That said, the stock is arguably pricing in the good news. At a price-to-earnings ratio of 38 and a price-to-free-cash-flow multiple of 34.6, Costco is on the expensive side of its historical valuation.
What's more, the confluence of macroeconomic factors is seemingly all working in Costco's favor recently. That could mean today's investors are paying a premium price for a company near its best. Investors would be prudent to wait for a further pullback in Costco's share price before starting a position in the excellent retailer.
