The key to investing success over the long haul is as simple as buying and holding ownership in businesses that possess strong competitive advantages. These are favorable factors that differentiate a business from its competition.
The membership mega-retailer Costco Wholesale (COST -0.39%) fits this requirement to a tee. And the blue-chip stock currently looks to be a no-brainer buy for investors seeking price appreciation and a growing dividend. Let's delve into Costco's fundamentals and valuation to further elaborate.
An economic moat that is a country mile wide
There are numerous types of competitive advantages, but Costco differentiates itself with cost leadership. Because of the size and scale that comes along with buying tens of billions of dollars of products from vendors each quarter, Costco has significant leverage over its vendors.
The company uses this leverage to get the absolute best deals on merchandise. These savings on products then trickle down to its members, with the company selling its products just above cost. This strategy results in prices that can't be beat by any of Costco's peers. And the company can afford to offer bargain-bin prices to its members because of the high margins of its membership business.
Costco recorded $54.4 billion in net sales during its first quarter ended Nov. 20, which was an 8.1% growth rate over the year-ago period. How did the large-cap company put up such solid growth for the quarter?
Costco's value proposition is so compelling that the company's paying household membership climbed 7% year over year to 66.9 million in the first quarter. This growth in members helped the warehouse retailer realize 6.6% comparable sales growth during the quarter. Coupled with a 2.3% higher warehouse count to 847, this explains how Costco's net sales grew at a high-single-digit clip for the quarter.
The company generated $3.07 in diluted earnings per share (EPS) in the first quarter, up 3% over the year-ago period. Due to the inflationary environment, Costco's merchandise costs grew at a faster rate (8.7%) than net sales during the quarter. That is why the company's net margin fell approximately 12 basis points year over year to 2.5% for the quarter. And it also explains how Costco's diluted EPS growth lagged behind net sales growth in the quarter.
Looking out over the next five years, analysts believe that growing membership and store counts will propel diluted EPS at a rate of 10.4% annually. For context, that is well above the discount store industry's estimated average of 7%.
Image source: Getty Images.
The dividend is poised to soar
Considering that the S&P 500 index's dividend yield is 1.7%, Costco's 0.8% yield probably isn't even on the watch list for most dividend investors. But the company also offers up a special dividend to shareholders every now and then.
Plus, Costco's dividend payout ratio is positioned to clock in just under 27% in the current fiscal year. Suffice to say this gives the company the necessary capital to open more stores and repay debt. That's why I believe that the dividend will grow at a slightly faster rate than earnings over the next few years, which could lead to low-teens annual percentage dividend growth during that time.
World-class stocks (almost) always fetch premium valuations
Costco's business is a perpetual winner. Unsurprisingly, this means that it often commands big premiums compared to its competitors.
The stock's forward price-to-earnings (P/E) ratio of 29.2 is meaningfully above the discount stores industry average of 22.1. But since Costco's growth prospects are superior to those of its peers by a sizable margin, this valuation is well-earned in my opinion. And given the company's high growth potential, it certainly should be on an income investor's radar.
