Costco Wholesale (COST 1.01%) doesn't have a lot of bells and whistles as a retailer, but that hasn't stopped the stock from delivering monster returns over its history.
Since its IPO in 1985, Costco's stock price has grown by more than 75,000%, turning a $1,000 investment into more than $750,000. That's not including dividends -- reinvested dividends along Costco's history raised the total return to 110,800%.
The retail giant was back in the news lately after announcing a $15-per-share special dividend. Costco has made a habit of paying out special dividends every few years, and the stock rocketed higher on the news. It's just the latest payoff for Costco shareholders as the stock trades at all-time highs.
Image source: Costco.
Costco's rock-solid business model
There's a lot to like about Costco as a business. The company's membership-based, buy-in-bulk business model has stood the test of time, withstanding challenges from Amazon and others, even as overall retail sales have gradually shifted to the e-commerce channel.
The strength of Costco's business model is largely in its simplicity. Costco sells high-quality goods at bargain prices to members who pay $60 or more per year for the privilege of shopping there. Most of Costco's profits come from its membership income, meaning the company operates the retail business nearly at cost. Costco's gross margins are significantly lower than those of conventional retailers. For example, in its most recent quarter, Costco recorded a gross margin of 12.7%, compared to 24.6% for Walmart and 28.5% for Target.
That might sound like a weakness, but it's really a sign of strength. It's evidence that Costco can charge lower prices than its conventional retail competitors, which keeps customers coming back to its stores and drives comparable sales and membership totals higher.
In its most recent quarter, the company's comparable sales, adjusted for gas prices and currency exchange, increased 3.9%, and membership fees, a good proxy for its member count, rose 8.2% to $1,082.
Costco is also due for a membership fee hike, which likely means its basic membership fee will go from $60 to $65 a year and its executive membership will go from $120 to $130.
Because the company is reliant on membership fees and caters to a higher-income customer base, the business is also much more recession-resistant than the typical retailer. However, there's one reason why Costco stock is worth avoiding in 2024.
Is Costco stock a buy in 2024?
While Costco's business model and historical performance may be enviable, the stock faces one major challenge heading into 2024. It's trading at a price-to-earnings ratio of 46, which is nearly as high as it's been in its history, as you can see from the chart below.
COST PE Ratio data by YCharts
As you can see, Costco's valuation has inflated significantly since the pre-pandemic years, when it was generally trading at a P/E below 30.
Valuation levels like Costco's current reading are generally reserved for faster-growing companies. While the resilience of its business model should earn it a premium, Costco's growth is constrained by the realities of retail spending growth and its low-margin business model. Investors shouldn't expect Costco's margins to significantly expand, as its business model means that it must keep prices, and therefore margins, low. Costco continues to open new stores, which should help grow its revenue, but same-store sales are unlikely to grow much faster than mid-single digits. In fact, the analyst consensus calls for Costco's revenue to grow just 4.7% this year and 6.6% next year.
The stock is up 48% year to date, but at its current valuation, its returns are likely to be much more modest in the coming years, and there's a significant risk of the stock pulling back 20% or 30% due to multiple compression, meaning its valuation falls to more normal levels. Additionally, with the special dividend now declared, the expectation of that payout won't be able to lift the stock.
Costco's still a great business, but investors are better off waiting for a better price to own a piece of this rock-solid company.
