Since the start of February, the S&P 500 is down about 5%, continuing a downward trend that really started at the beginning of 2022 more than a year ago. Investors have a lot to be pessimistic about right now, including inflation that is still at high levels, and the recent issues facing the banking industry. Putting money to work in this type of uncertain environment might be a scary idea.
Among the chaos, there are still some outstanding businesses that might warrant a closer look from investors looking for a safer place to park their capital. Costco (COST 1.01%) is one example. The top retail stock is down 20% from its peak and 6% since the start of February (as of this writing).
Does this make Costco a buy today? Let's take a closer look.
A unique business model
With its global footprint of 848 warehouses, Costco isn't a typical retailer. For starters, customers must pay an annual membership fee to even have the ability to shop at its locations. The company currently has 123 million member cardholders, which was up more than 7% year over year. And Costco's membership renewal rate was 90.5% globally, demonstrating the loyalty customers have toward the retailer.
It makes sense why retention remains strong. Costco is known to have the lowest prices around. And just because prices are low, with a gross margin consistently in the 12.5% to 13% range, doesn't mean customers sacrifice quality. Costco carries products from nationally recognized brands, as well as offering its own private label, Kirkland Signature, which is known to be extremely high-quality.
At a high level, it's strikingly clear why this company has succeeded for so long. Because Costco is able to buy merchandise from its suppliers in such large quantities, it can flex its bargaining power to lower the per-unit cost of goods. These savings are then passed on to customers in the form of low prices. It's a hard setup for any rival to compete with.
While Costco is already massive, with trailing 12-month net sales of $230.1 billion, this business still has growth potential. In fact, between fiscal 2017 and fiscal 2022, net revenue increased at a compound annual rate of 12%, impressive for an enterprise of this size. Looking ahead, management continues to open new warehouses, with 24 net new locations slated to open in the current fiscal year. And in China, a big growth market, Costco will have five warehouses by fiscal year-end, compared to two at the start of the year.
A premium valuation
Costco shares have performed extremely well over the past five years, rising 161% (as of March 17), absolutely trouncing the broader S&P 500's total return of 57%. As a result, Costco's stock now trades at a price-to-earnings (P/E) ratio of 36. The valuation has come down considerably since the start of 2022, and now the stock trades in line with its trailing five-year average P/E. Nonetheless, Costco is still more expensive than its peers Walmart, which has a P/E of 32, and BJ's Wholesale Club, which has a P/E of 20.
Adding fuel to the fire is the fact that Costco isn't exactly immune to what's going on with the economy. The company's sales soared by double digits in fiscal 2021 and fiscal 2022. But in the most recent fiscal quarter (second-quarter 2023 ended Feb. 12), Costco saw a more pronounced slowdown, with net revenue and same-store sales up 6.5% and 5.2%, respectively. To be fair, this is still a healthy gain, but it's a clear sign that Costco's operations are hitting the brakes.
Despite these near-term challenges that Costco is dealing with, investors might still want to consider adding the stock to their portfolios, even with the premium valuation in mind. This is one of the best businesses in the world, with a loyal customer base. What's more, Costco has stood the test of time, proving its durability no matter what is happening with the economy. Even in the face of elevated inflation that is forcing people to stretch their budgets, it was very encouraging to see that traffic at Costco's warehouses was up 5% in the latest fiscal quarter.
Investors have to decide for themselves if it's worth paying up for a company like Costco right now. Shares are well off their highs, which might mean now is a good time to be a buyer.
