Costco Wholesale (COST 1.01%) has seen its share price soar 157% over the last five years, nearly tripling the return of the S&P 500. That momentum has left the company in possible stock-split territory -- with the stock now trading at a sizable $569 per share.
But whether Costco actually goes ahead with a split at some point is hard to know and immaterial for investors. What matters most is the significant and sustained share price appreciation that results from a business with solid fundamentals.
And Costco is certainly such a company. Indeed, its stock currently commands a consensus rating of "buy" among Wall Street analysts. The median price target of $600 per share implies only 6% upside from its current price, but investors should still give the stock a closer look. Here's why.
The investment thesis for Costco
Membership-based retailer Costco benefits from significant scale, prodigious brand authority, and operating excellence. Specifically, as the third-largest global retailer, Costco has substantial purchasing power. But the company reinforces that cost advantage through skilled inventory management and an efficient business model.
For instance, Costco carries just 4,000 stock keeping units on its shelves, far less than the 30,000 stock keeping units found at most supermarkets. In high-volume stores, that strategy forces suppliers to compete on price for limited shelf space. Costco also offers generic products through its Kirkland Signature private label when it believes name brands are too expensive. Those generic products generally sell for 20% less, yet they earn higher margins.
More broadly, Costco operates somewhat bare-bones warehouses where consumers expect to buy in bulk, enabling the company to generate more revenue per square foot than other retailers. The combination of operating efficiency and cost advantages allows Costco to pass along substantial savings to cardholders.
As a result, the company has earned a reputation for quality merchandise at bargain prices, and that has translated into solid financial results on a relatively consistent basis.
Beating expectations in the latest quarter
Costco topped consensus estimates on the top and bottom lines in its fiscal fourth quarter (ended Sept. 3), but challenging macroeconomic conditions continued to weigh on consumer spending. Fourth-quarter revenue rose 9.5% to $78.9 billion, reflecting 5% growth in store traffic offset by a 4% decline in average ticket price.
Meanwhile, GAAP net income climbed 15.6% to $2.2 billion as cost control efforts, product mix, and higher interest income contributed to slight profit margin expansion. The income statement visualization below provides further detail:
Image source: The Motley Fool.
One important takeaway from the fourth-quarter report is that while consumers shied away from big-ticket items, they still visited Costco more frequently in spite of (or perhaps because of) elevated inflation. That highlights the value and durability of Costco's business model.
Similarly, Costco reported membership growth of 8% during fiscal 2023, and its global renewal rate remained above 90%. That trend also points to value in Costco's business model, and its ability to maintain consumer loyalty should help the company defend its position as the third-largest global retailer in the coming years.
On that note, global retail sales are expected to increase at 4.2% annually through 2027, but Costco should outpace the industry average as it opens new warehouses, onboards new members, and drives greater frequency among cardholders.
Costco stock trades at a pricey valuation
Costco is a wonderful business (whether or not it splits its stock in the future) and its above-average valuation reflects its highly esteemed position in the industry. The stock currently trades at 40 times earnings, a premium to the five-year average of 37 times earnings. That tops the multiples the market affords Walmart and Target, which trade at 31 times earnings and 15 times earnings, respectively.
The stock's current valuation looks pricey compared to consensus forecasts from Wall Street, which call for annual earnings growth of roughly 10% over the long term. To be fair, Costco consistently trades at an elevated valuation, and it has still outperformed the market over the last three- and five-year periods. So investors may have to bite the bullet to get a piece of this company.
Personally, I am more inclined to wait for a cheaper valuation. But if I did buy this stock today, I would start with a very small position, no more than 1% of my portfolio.
