Costco Wholesale (COST 1.01%) hasn't drawn much investor enthusiasm lately. Its stock is down 7% over the past year, and it fell after the second-quarter earnings release last week.
But forward-thinking investors shouldn't get too ruffled by its short-term challenges. Every company will deal with stumbles, and in Costco's case, it's less about the business and more about the economy. Current performance is only a snapshot in a long story, and growth is almost never linear.
So let's instead examine what Costco might look like over the next several years.
More members, higher sales, and even higher earnings
Costco's membership is what keeps the company growing. It charges an annual fee for shopping at its warehouses, and in exchange, customers get unbeatable prices on a range of products, including fresh food, travel, and furniture.
Membership growth has been very high, coming in at around 7% year over year for the past few quarters. It was somewhat lower than that prior to the pandemic and the following inflationary period. However, as Costco opens new stores and expands its presence, membership becomes available to more people, making that higher percentage for membership increases likely to persist.
But let's take 6% as a possible average for annual membership growth. As of the end of the second fiscal quarter, which was Feb. 12, Costco has 123 million cardholders worldwide. Using a 6% compound annual growth rate (CAGR), Costco could have close to 165 million cardholders by 2028, and that might be slightly conservative.
As for sales, growth was in the high double digits for about two years before decelerating to 6.5% in the second quarter. Prior to the pandemic, sales increases were in the mid-to-high single digits, so let's take 6% again for a CAGR. Trailing-12-month revenue was $234 billion, so five years from now, it could be somewhere around $313 billion.
Net income growth is typically higher than sales growth, but it's also more variable, so let's use 10% as a possible average growth rate. Net income for the trailing 12 months was $6.05 billion, so in five years, it could be around $9.7 billion.
Robust global expansion
Considering its size, Costco actually has a fairly low store count. It runs 584 stores in the U.S. and 848 globally. It plans to open 24 net new stores in fiscal 2023, and it typically opens between 20 to 25 stores in a given year. If we take 22 per year as a conservative estimate, that should bring it up to about 960 stores in 2028.
Chief Financial Officer Richard Galanti pointed out that international stores are more profitable than U.S. stores, and that's where the major expansion opportunities are.
A reasonable expectation for stock gains
Let's see if we can determine a reasonable forecast about what Costco stock might look like in five years. The market isn't rational or predictable, so this is really an exercise and not any type of modeling or predictive measure.
Costco stock has gained more than three times the S&P 500 over the past five years. That's not an indication of the future, but considering that Costco's model is reliable and quite the same as it was five years ago, it gives us a clue to its potential.
Next, let's use the average price-to-earnings (P/E) ratio and compare it to earnings growth to see where the price might reasonably fall. Costco stock is trading at 35.7 times trailing-12-month earnings, and its five-year average is 36.5. Let's use 36 as a possible average P/E for the next five years.
Now, let's multiply earnings per share (EPS) by our estimated 10% annual increase in net income, assuming no change in the amount of shares. We can assume that because Costco has tons of cash and doesn't need to raise money to operate or pay its dividend. Trailing-12-month EPS is $13.61, so in five years it would be $21.91. With a P/E ratio of 36, that gives us a five-year target stock price of $789, or about a 60% gain from today's price.
Should you buy Costco stock?
A 60% gain over the next five years would be a slowdown from the last five years. Then again, this is completely hypothetical, since we don't know what any growth rates will be, and the market doesn't always price stocks predictably.
Growth investors might want to look elsewhere, but value investors should recognize Costco's reliability and stability, not to mention its dividend. It's an excellent value addition to a diversified portfolio with a long-term horizon.
