Timing the purchase of a stock to when it hits rock bottom is very difficult. After all, no one has a crystal ball. Fortunately, shareholders who intend to hold a stock for a long time don't have to get the exact timing right. You're simply looking for strong businesses that sell at a reasonable price.
Long-term Costco Wholesale (COST 1.01%) shareholders have been handsomely rewarded over the years. Over the past decade, the share price has appreciated by 387%, trouncing the S&P 500's 176% gain. Costco has compelling growth opportunities, but is it poised to continue outperforming the market?
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Repeatable success formula
Costco has built its reputation on selling a broad array of high-quality merchandise in bulk. It has the power to negotiate with vendors, giving it the ability to offer members low unit prices
You have to purchase a membership to shop at the warehouse, but people clearly find it worthwhile. Retention rates have hovered around 90% for several years. And Costco has consistently added new members. It had 69.1 million paid members at the end of its fiscal third quarter (ended May 7). That's up from 65.8 million at the end of the last fiscal year (ended Aug. 28, 2022).
Overall, Costco's business has generated increasing profitability. However, in the latest quarter, its operating profitability fell by 6.3% to $1.7 billion. This was partly due to higher selling, general, and administrative expenses, which management largely attributed to increased wages and benefits. While the retailer has been cautious about raising membership fees -- its last increase was in 2017 -- when it does boost prices again, it will help profitability.
Sharing the wealth
Costco generates plenty of free cash flow (FCF). During the first nine months of fiscal 2023, its FCF was $4.6 billion. Management returns this to shareholders via repurchases and dividends. Costco has a $4 billion repurchase program, and it has used it astutely. During the first three quarters of fiscal 2023, it spent $446 million. Paying an average price of $492.30, that's well below the current stock price.
Although the stock's 0.8% dividend yield may not seem impressive, Costco's board of directors has raised the dividend annually, including increasing May's payout by 13.3% to $1.02. It has also paid a large special dividend every few years. The last one was in December 2020, when shareholders received a $10 payment.
Valuation
Since the start of 2023, Costco's stock price has increased by nearly 20%, besting the S&P 500's 17.3%. Unfortunately, Costco's shares sell at a relatively rich valuation. The stock has a price-to-earnings (P/E) ratio of 41. That compares to 26 for the S&P 500.
For value investors, it's tough to swallow paying a large premium. But Costco still offers growth prospects with plans to open additional warehouses. It opened 14 warehouses, excluding relocations, during the first three quarters of 2023 and had 853 at the end of May. The company planned on expanding the count by another nine in the final quarter.
For long-term investors, Costco remains a good opportunity. Those who are concerned about the current high valuation could build a position over time by dollar-cost averaging. Buying shares this way can help smooth out your cost basis out since you make equal dollar purchases on a schedule, such as quarterly or annually.
