Last summer, stock splits were all the rage on Wall Street, with popular stocks Alphabet, Amazon, and Tesla participating in the excitement. Since then, the enthusiasm surrounding stock splits has waned as the stock market has struggled to return meaningful gains. Nevertheless, for companies with high-priced stocks, dividing their shares could potentially enhance accessibility for retail investors by making them more affordable.
Costco (COST -0.55%), a membership-only retailer, is one company that could benefit from a split, as its stock is close to $500 per share. Let's delve into the potential outcomes of a stock split and examine whether Costco might consider such a move.
What is a stock split?
A stock split is a method companies use to boost the number of their shares without changing the company's overall value. When a company chooses to split its stock, it doesn't affect the worth of your investment; instead, it adjusts the number of shares you own.
To illustrate, if you purchased 10 shares of a company valued at $100 per share, and the company decides on a 2-for-1 stock split, you would then hold 20 shares valued at $50 each. Therefore, despite owning twice the number of shares, the total value of your investment remains unaffected at $1,000.
Why would Costco split its stock?
As a stock reaches a high price, it can present an obstacle for prospective retail buyers, who might perceive it as financially out of reach. It's worth noting that while there are brokerages that facilitate the purchase of fractional shares, prominent ones, such as Vanguard, don't extend the option to their clients, limiting accessibility for those seeking to invest in such high-priced stocks.
A lower share price could make the stock more affordable to a broader range of investors, potentially leading to increased demand for the company's shares and a subsequent rise in its stock price.
A lower stock price can also give a company's employees more flexibility in managing their equity through compensation packages or employee stock purchase plans. Tesla, the Elon Musk-led automotive and solar company, has split its stock twice over the past three years and asserts that a lower stock price is beneficial for attracting and keeping talented employees.
Costco has split its stock before
Costco has split its stock three times over its nearly 40 years as a publicly traded company. The last occurrence, a 2-for-1 split, happened in 2000. The 23 years since its previous stock split is the most prolonged period in the company's history, with the next longest being eight years.
Image source: Getty Images.
CEO W. Craig Jelinek was appointed to his position in 2012, meaning he has yet to oversee a stock split. Notably, neither Jelinek nor any C-suite member has commented on the potential of a split.
Is Costco a buy ahead of a potential stock split?
It's generally advised against making investment decisions solely based on the possibility of a stock split. The financial performance of a company carries significantly more weight when evaluating the long-term potential of a stock.
Costco continues to enjoy immense popularity among its members, boasting an impressive base of 124.7 million cardholders worldwide and an impressive global renewal rate of 90.5%. Over the past year, the wholesale retailer experienced a notable membership growth of approximately 7%, further solidifying its position in the market.
Now let's examine how Costco's robust membership base translated into its financial performance. For the first three quarters of its fiscal 2023, Costco generated $163 billion in revenue, resulting in $4.1 billion in net income. Those figures represent year-over-year growth of 5.5% and 4%, respectively.
While Costco's sales and net income growth could be more impressive, the company has an incredible balance sheet, with net debt (long-term debt minus cash) of $7.2 billion. With its excess cash, management could soon continue its trend of issuing special cash dividends. Notably, the company has averaged such dividends approximately every three years, with the last in December 2020 for $10 per share.
The downside to Costco's stock is that it's expensive by common valuation standards, with a price-to-earnings (P/E) ratio of 38. Not only is Costco's P/E ratio higher than its five-year of 37, but it's also higher than those of its competitors, Walmart and Target, at 36 and 23, respectively.
COST PE Ratio data by YCharts
Still, there's a reason for Costco's valuation, as the stock has delivered a total return (price appreciation plus dividends) of 468% over the past 10 years, more than doubling the S&P 500's return of 210% during the same period.
To sum up, Costco has long been a fantastic business with an unmatched balance sheet, resulting in market-beating returns. That makes Costco's high stock price warranted, but based on valuation alone, investors might want to wait for a discount before buying.
