According to the Bureau of Labor Statistics, the consumer price index increased 8.3% year over year in August. That inflation metric -- based on the prices of a basket of commonly purchased goods and services -- was higher than analysts' consensus forecast. This suggests that U.S. consumers will need to modify their shopping habits if they haven't done so already.
Few companies are in a better position to benefit from that than discount retailer Costco Wholesale (COST -0.12%). Here's the case for why Costco stock is a compelling pick for growth-oriented investors.
The business model is thriving
Costco is a membership-only chain that offers basic membership plans for $60 a year and executive memberships for $120 annually. For both consumers and businesses seeking to stretch their money, the retailer is a clear winner.
The company has grown itself to its current market capitalization of $211 billion in part by using economies of scale and passing the savings stemming from that on to its members by selling its products at limited markups. The model banks on the fact that members will shop at its stores more frequently to get as much value out of their memberships as possible. Costco had grown its member base to a staggering 65.8 million households and 118.9 million cardholders as of the end of its fiscal 2022 on Aug. 28.
In its fiscal fourth quarter, Costco generated $72.1 billion in revenue (up 15.2% year over year), so what led to such spectacular growth for the company? Costco has strong appeal to both existing members and prospective members. This was reflected in the fact that the company's number of warehouses grew by just under 3% to 838 last fiscal year. Yet its total membership and cardholder count grew by 6.5% -- more than twice as fast. This dynamic is how Costco's same-store sales surged 13.7% higher year-over-year during the fourth quarter.
Clearly, consumers are seeking out values and bargains more than they would otherwise due to the inflationary environment. And Costco performs a masterful balancing act between delivering bargain prices to its members and churning out reasonable profits.
In fiscal Q4, the company's diluted earnings per share (EPS) increased 11.7% over the year-ago period to $4.20. However, its merchandise costs grew at a 16.1% clip -- faster than its total revenue growth -- which is why its net margin contracted by 7 basis points to 2.6% during the quarter. That's why Costco's diluted EPS growth lagged behind its total revenue growth.
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A low dividend obligation
At the current share price, Costco's dividend yields just 0.8% -- meaningfully lower than the S&P 500 index's average 1.7% yield. Nevertheless, long-term income investors who have many years to hold on and let the payout growth compound will probably appreciate the stock.
The company's dividend payout ratio will likely come in around 26% for the current fiscal year. That's more than enough retained earnings for Costco to further grow its store count and strengthen its balance sheet. This excess of capital is why analysts believe that the company's diluted EPS will grow at an annualized rate of 13.8% through the next five years, which should lead to similar dividend growth during that stretch.
The valuation is buyable
By valuation, Costco isn't the cheapest retailer out there. Its forward price-to-earnings ratio of 29.4x is significantly above the 20.7x average among discount stores. However, this valuation seems to be justified by its above-average growth profile. Analysts are projecting 13.8% annual diluted EPS growth from Costco, which is much better than its peer average of 10.6%.
Simply put, Costco stock has a track record of being a tremendous wealth builder, and its fundamentals appear to be intact. Arguably, that justifies the retailer's current valuation for growth investors.
