The membership warehouse retailer Costco (COST -0.12%) has made shareholders significantly richer in the last decade. A $10,000 investment in the stock made 10 years ago would now be worth approximately $56,000 with dividends reinvested. For context, that is well above the $31,000 that the same investment amount in the S&P 500 index would have grown into during that time.
Investing comes with the following caveat: Past performance is no guarantee of future results. And while this does hold true, wealth-building, winning stocks typically continue to do well in the long run as long as the investment thesis remains intact. This raises the following question: Is Costco still a buy for dividend growth investors looking to build meaningful wealth? Let's take a look at the company's fundamentals and valuation to decide.
Churning out solid growth
With nearly 850 warehouses spread throughout North America, Asia, Europe, and Oceania, Costco is a brand that is recognized in most economically developed nations. This brand recognition explains how the company's market capitalization is currently a staggering $213 billion.
Costco's total revenue surged 6.5% higher year over year to $55.3 billion in its fiscal second quarter ended Feb. 12. The company's warehouse count grew by 2.4% over the year-ago period to 848 for the quarter. Because it expanded into numerous additional markets where people were eager to become new members, Costco's total cardholder count increased at a year-over-year rate of over 7% to 123 million during the quarter. These factors explain how the company's total comparable sales edged 5.2% higher over the year-ago period.
Mid-single-digit top-line growth is a deceleration from the double-digit growth rates delivered over the last couple of fiscal years. But this isn't so bad considering the difficult macroeconomic environment. Besides, the company has plenty of levers that it can pull to keep the bottom-line growth chugging along.
Costco's diluted earnings per share (EPS) soared 13% year over year to $3.30 in fiscal Q2. The company generated approximately 70% of its $1.4 billion in profits from membership fees for the most recent quarter, which is how Costco can sell products at almost no markup to members.
Due to the company's admirable cost control, merchandise costs only increased by 6.4% during the quarter. This explains how Costco's net margin expanded by 15 basis points to just shy of 2.7% in the quarter. Along with a 0.1% reduction in the company's outstanding diluted share count, this is why diluted EPS growth far exceeded total revenue growth for the quarter.
As Costco attracts more members with new store openings, earnings should continue to grow at a quick pace. Analysts anticipate that the company's diluted EPS will compound at 9.9% each year through the next five years. Putting this into perspective, that is about twice the discount stores industry average earnings growth outlook of 5.2%.
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A payout with huge growth potential
Considering the S&P 500 index's 1.7% dividend yield, Costco's 0.8% yield isn't going to wow income investors with immediate income. But aside from the market-beating returns the stock has delivered to shareholders in the past 10 years, it has also generated massive dividend growth. Costco's quarterly dividend per share has more than tripled over that time from $0.275 to the current rate of $0.90.
And since the dividend payout ratio is poised to come in at around 26% for the current fiscal year ending in August, double-digit annual dividend growth should persist for the foreseeable future. This arguably makes up for Costco's below-average starting dividend yield.
The stock's valuation is justified
Down 11% over the last year, shares of Costco have been punished about as much as broader markets. But this could be a buying opportunity for dividend growth investors.
Costco's forward price-to-earnings (P/E) ratio of 30 is much greater than the discount stores industry average forward P/E ratio of 21.4. However, this premium valuation can be rationalized by Costco's superior growth prospects. That is probably why analysts have an average 12-month price target of $547 for the stock, which is equivalent to a 15% upside from the current $475 share price.
