Costco (COST 1.01%) has endured four major U.S. recessions since the company went public in 1985. Yet the warehouse retailer's stock has still generated a total return of about 74,500% since its 1985 IPO, making it one of the greatest stocks of the past four decades.
But can it continue to grow as inflation, rising interest rates, and other macroeconomic headwinds rattle consumers and the markets? Let's review three reasons why I think you should buy Costco stock now -- and one reason why you might want to sell it.
Reason to Buy No. 1: Its evergreen business model
Costco's recipe for steady growth consists of three basic ingredients. First, it leverages its scale to buy and sell bulk quantities of products at lower prices than Amazon, Walmart, and other large rivals. That model also strengthens its defenses against online marketplaces, since it's usually cheaper for customers to pick up those large products instead of having them shipped to their homes.
Second, it locks in its customers with sticky annual membership plans. It generates most of its profits from its membership fees, not its low-margin retail sales. That profit engine helps it push through inflationary headwinds and cyclical slowdowns in consumer spending.
In its latest reported quarter, Costco's membership renewal rates hit all-time highs of 92.3% in the U.S. and Canada and 90% worldwide. Its total number of cardholders also increased 6% year over year to 116.6 million. That impressive growth gives Costco plenty of latitude to raise its membership fees (as it has done every five to six years) to offset inflation and other macroeconomic headwinds.
Lastly, Costco continues to expand its physical footprint even as other retailers are shuttering brick-and-mortar stores to cut costs. It ended its latest quarter with 830 warehouse stores, compared to 809 a year prior, and it continues to expand its presence in Europe, Asia, and Australia.
Reason to Buy No. 2: Consistent comps growth
Costco's adjusted comparable-store sales -- a metric that excludes the impact of changes in gas prices and foreign currency exchange rates -- consistently rose before the pandemic, throughout the crisis, and in the post-lockdown market.
|
Market |
Adjusted Comps Growth Fiscal 2019 |
Adjusted Comps Growth Fiscal 2020 |
Adjusted Comps |
Adjusted Comps |
|---|---|---|---|---|
|
U.S. |
6.4% |
9.2% |
13.6% |
10.7% |
|
Canada |
5.3% |
7.4% |
12.1% |
11.2% |
|
Other International |
5.6% |
11.2% |
13.4% |
9.6% |
|
E-commerce |
23.3% |
50.1% |
42.6% |
11.3% |
|
Total Company |
6.1% |
9.2% |
13.4% |
10.6% |
Data source: Costco. Excludes fuel and foreign currency impacts. Costco's fiscal years end Aug. 31. *Through the first nine months of the fiscal year.
That pattern of growth continued in May when Costco's total adjusted comps increased 11.8% year over year, rising 10.7% in the U.S., 19.5% in Canada, 10.1% internationally, and 7.7% across its e-commerce channels.
Reason to Buy No. 3: Stable operating margins
Inflation, which recently hit a 40-year high in the U.S., will likely be a near-term drag on Costco's gross margin. However, inflation could also generate revenue tailwinds for its warehouse stores as consumers purchase more products in bulk to counter soaring costs. The company can also continue to offset its rising costs with its membership revenue.
Its adjusted gross margin (which also excludes gas price changes) declined 17 basis points year over year to 11.05% in the first nine months of fiscal 2022 as it sold a higher mix of lower-margin food items.
However, during those nine months, it also reduced its sales, general, and administrative (SG&A) expenses to 9.04% of its revenue, compared to 9.85% in the prior-year period. As a result, its operating margin still expanded year over year from 3.33% to 3.42%.
1 reason to sell Costco: Its valuation
Analysts expect Costco's revenue and earnings per share to rise by 15% and 16%, respectively, in fiscal 2022. Next fiscal year, they expect its revenue to grow 8% and earnings per share to increase 10%.
That would be impressive growth, but Costco's stock already trades at more than 30 times next year's earnings. Walmart (which owns Costco's warehouse club rival Sam's Club) and Target currently trade at 17 and 11 times forward earnings, respectively.
Costco's higher valuation could limit its upside potential in this volatile market, which favors cheaper value plays over stocks with a premium. Therefore, it might be prudent to wait for a pullback instead of going all-in on Costco as a recession-resistant long-term investment.
The strengths still outweigh the weaknesses
Costco stock isn't cheap, but I believe it deserves its premium valuation. Its business easily withstood previous economic downturns, and it will likely emerge from the current inflation cycle as a much stronger retailer. Investors can accumulate some shares of Costco right now, but they should also brace for a lot of near-term volatility and be ready to add more shares if its price tumbles even further.
