Costco Wholesale (COST 1.01%) is cracking down on people sharing memberships, particularly at self-checkout lanes. Consumers may not love the idea but it's a good move for the business and investors. Here's why the stock is a much better buy as Costco tightens up its membership policies.
1. It'll increase membership fee revenues
Membership fees are an important part of Costco's business model as they allow the company to price products more competitively and bolster its gross margin. Typically, they have accounted for over 2% of the company's revenue. However, in the past couple of years with spending growing rapidly, that ratio has fallen below 2%:
Data source: company filings. Chart by author.
By cracking down on people sharing memberships, Costco may be able to increase the number of memberships and improve this ratio in the future.
2. It'll increase overall revenue
One of the immediate impacts of an increase in memberships is that not only will Costco's revenue from memberships increase, but it will also likely lead to an increase in overall spending as well. After all, if members are paying $60 a year, they may have some additional motivation to justify that cost and make more trips to the big-box retailer. And there's evidence to suggest that is the case.
Costco's annual revenue has risen by 129% over the past 10 years, which works out to a compound annual growth rate (CAGR) of 8.4%. And during that time, the number of paid memberships has increased by only 78%. It's an encouraging trend that suggests there's more incentive for the company to increase memberships beyond just increasing membership revenue -- in-store sales will likely increase as well.
3. It can help the stock achieve better returns
Over the past five years, Costco's stock has risen by around 150%, outperforming the S&P 500 during that stretch, with the index up by just 58%. But for the retail stock to continue doing well, the business needs to be growing.
One problem with the stock today is that it trades at 39 times its trailing earnings. That's a steep multiple, but investors justify it as they're likely factoring in the growth the company will achieve in the future. If investors didn't expect Costco to grow and continue to dominate, then the stock wouldn't fetch as high of a premium as it does today.
That's where tightening up on membership policies and increasing the number of members, which, in turn, can help drive sales growth, is important for the company's future. These policy changes may seem like small moves for a company, but Costco's gross and operating margins are thin, and that makes it all the more important for the company to generate as much revenue as it can.
COST Gross Profit Margin (Quarterly) data by YCharts
As a matter of fact, membership fees accounted for 75% of Costco's net profit in the last quarter. You can almost think of Costco as a subscription-based club that also happens to sell some groceries, electronics, and gas as a side gig. Those fees play a crucial part in the company's business plan.
Is Costco's stock a buy?
By enforcing tighter membership policies, Costco helps itself by increasing its member count and, ultimately, creating a catalyst for future growth. With tight margins, it needs the additional revenue it can get for its earnings to grow.
Overall, this is a good move for Costco and one that should pay off for its business. And that's why for investors, this can still make for a great stock to buy and hold as the business continues to have strong growth prospects.
