I think that the best way to judge whether an investment was successful or not is to look at a five-year time horizon, at least. This way, you can gauge how the fundamentals have performed over time. Costco (COST +0.50%), for example, has seen its stock price rise 158% in the last five years, thanks to rising sales and profits.
However, it has been a rough stretch recently, as Costco's shares are down 21% from their peak in April last year. Is now the time to buy? Let's take a closer look at what investors should know.
NASDAQ: COST
Key Data Points
Costco is registering slower growth
Costco's net revenue jumped 17.7% in fiscal 2021 and 16% in fiscal 2022. The last time this top retail business saw double-digit top-line gains was in fiscal 2012. Costco's operations were boosted by the coronavirus pandemic, momentum that carried over into the last fiscal year.
But things are slowing down. In the most recent fiscal quarter (second-quarter 2023 ended Feb. 12), net sales were up just 6.5% to $54.2 billion, with same-store sales up 5.2%. In the month of February, same-store sales increased only 3.5%. However, diluted earnings per share did grow 13% in the quarter, which is a positive sign.
Management pointed to weakness in "big-ticket discretionary departments" as pressuring sales lately. However, they do see the inflation situation improving. Even more encouraging is that foot traffic was up year over year globally.
This is a special business
Despite the fact that Costco is facing a slowdown right now, it's strikingly clear that this is a fantastic business. Costco's trailing 12-month net revenue of $230.1 billion makes it the world's third largest retailer. And this gargantuan scale means that the company can negotiate better terms with its suppliers, savings that are always passed on to shoppers in the form of low prices.
Costco's gross margin has been in the 12% to 13% range over the past decade, a sign that management does not intend to significantly mark up the prices for its merchandise. It could even be argued that this is more like a charitable organization instead of a profit-seeking enterprise, intentionally operating at low margins in order to better serve its customers.
Its obvious scale advantages, which lead to low prices for consumers, allow Costco to also benefit from tremendous customer loyalty. Offering a no-frills shopping environment where prices are the lowest around is hard to beat. This value proposition was on full display in 2020 and 2021, when people favored Costco's warehouses to tackle their shopping lists at one stop.
What's more, Costco's membership business model provides another source of revenue, driving higher loyalty and raising switching costs for customers. In the latest fiscal quarter, membership fee income was 6.2% higher than the prior-year period. And the renewal rate remains strong, at 92.6% in the U.S. and Canada and 90.5% worldwide.
An under-the-radar trait of Costco is that it has proven pricing power. I'm not talking about the merchandise that it fills its warehouses with, but the annual membership fee. The last time the company increased its fees was in 2017. And if history is any guide, Costco is about due to implement another one.
"It's a question of when, not if," CFO Richard Galanti said on the first-quarter 2023 earnings call when an analyst asked about hiking membership fees. Because of the unmatched value people receive from being Costco members, it's hard to imagine the renewal rate dropping meaningfully if fees were raised, even if a potential recession is on the horizon later this year.
Consider the valuation
As of this writing, Costco's stock trades at a price-to-earnings (P/E) ratio of 36. While this is a steep discount to where it was in late November 2021, when it approached a P/E of 50, the current valuation could undoubtedly be viewed as expensive by investors. After all, the broader S&P 500 index trades at a P/E of about 18 today.
But let's not ignore Costco's remarkable 158% return over the past five years. Boosting shareholder gains are special one-time dividends, the last one being $10 per share paid out in fiscal 2021. Moreover, Costco's stock only dropped 14% in 2022, compared to a 19% loss for the S&P 500 and a 33% drop for the Nasdaq Composite Index.
Owning a safe, steady, predictable, and durable business could very well warrant paying a premium valuation, especially right now.
