Costco Wholesale (COST 1.01%) is one of the most solid retailers in existence. Its product selection and low prices have helped it build a huge following, and renewal rates on its memberships have consistently stayed above 90%. Such growth has drawn the longtime support of investor Charlie Munger, who has sat on Costco's board since 1997.
But it has also become a symbol of a successful company that is arguably not a compelling investment. Hence, investors may want to consider the following factors before deciding to buy shares in the retailer.
The success of Costco
At first glance, criticizing Costco stock might seem counterintuitive. It began as a warehouse retailer on the West Coast in 1983. Now, 40 years of growth have taken it to 46 U.S. states and 14 countries across four continents.
With a loyal following and low prices, almost 91% of its members worldwide choose to renew annually. And its potential to expand internationally and the success of its business centers in North America mean the growth could persist for decades.
This expansion has delivered massive returns for its early investors. Since launching its initial public offering in 1985, the stock has risen nearly 61,000%, making it one of the most successful retail stocks in history.
Unfortunately for new buyers, a high valuation has contributed to those high returns. Thanks to this success, Costco stock sells at a price-to-earnings (P/E) ratio of just over 40, and throughout the 2020s, its price-to-earnings multiple has rarely fallen below 35. That does not compare well with retailers like Sam's Club parent Walmart, regional warehouse BJ's Wholesale, or Target, which usually trade at much lower valuations.
COST PE ratio data by YCharts.
The two things investors should know
First, that high P/E comes at a time when sales growth has changed for the worse. In past years, Costco had consistently delivered sales growth in the high single digits or low double digits. That track record probably helped lead to its multiple expansion.
Nonetheless, the August report points to a yearly sales growth rate of 4% over the four weeks. This might point to slowing growth since sales increased by 5% annually over a 52-week period.
This has led to the second problem: a relatively low payoff. In the first three quarters of 2023, net income was $4.1 billion, an increase of 4% compared with the same period one year ago. And its annual dividend of $4.08 per share yields around 0.75%. This is half the 1.5% of the S&P 500.
Worse for prospective buyers, the stock appears expensive given these numbers. One such investor who may have taken notice is Munger's investment partner, Warren Buffett. After owning positions dating back to 1998, Buffett and his team at Berkshire Hathaway closed their Costco position in 2020.
Costco has risen since that time, but it grew more slowly than the S&P 500. This indicates that Buffett and his team made the right call, and considering this situation, such a performance could motivate other investors to sell or avoid the stock entirely.
Making sense of Costco stock
Ultimately, Costco stock should slowly trend higher, but only at a tepid pace. The company will likely remain one of the most successful retailers, and its expansion could continue for decades.
However, its slowing growth combined with a high valuation does not bode well for investors, and the stock's performance during the 2020s validates the decision made by Buffett's team to sell. Although the retail stock will probably rise long term, the prospects for outperforming the S&P 500 appear increasingly grim.
