In the past 10 years, Costco Wholesale (COST 1.01%) shares have been a huge market outperformer, rising 700% since February 2014, including dividends. Strong fundamentals have propelled this eight-fold return. If you were smart enough to have purchased shares back then, a big congrats to you.
I'm sure the hope is that a repeat performance is in the cards. So where will this leading retail stock be a decade from now? The answer might surprise you.
Unique in the retail sector
One of the key reasons that the retail industry is so difficult to find lasting success in is because of how low margins are. There's a constant battle going on between customers and merchants. The former want prices to be as low as possible to obtain the best value, while the latter wants higher prices to cover expenses and to earn a profit.
Costco has figured out a way to achieve both of these goals. It's able to mark prices up on average by only 11%, well below other big-box retailers, which is what shoppers love to see. But Costco has also been able to increase its profits over time, thanks in large part to its growing membership base.
Looking out over the next 10 years, I don't think Costco's operations are going to change much. In 2034, I see the business still selling low-cost merchandise via its network of warehouses across the U.S. There might be greater activity on the e-commerce front, but I believe the physical shopping experience will still be the main attraction.
Of course, Costco is going to have a much larger number of stores in the future. In the last 10 years, the store count expanded at a compound annual rate of 3%. Management opened 23 net new locations in fiscal 2023, with plans to open 31 in the current fiscal year. There is a lot of potential not just in the U.S., but also in China over the long term.
It's reasonable to expect the company to continue growing its revenue and earnings at a solid clip, too. The threat of disruption is minimal, thanks mainly to Costco's massive scale. It's hard for smaller chains to compete with Costco's ability to obtain favorable pricing from suppliers.
The thriving membership model is also helpful in promoting Costco's durability. Memberships carry a 90% renewal rate worldwide, driving loyalty and repeat purchase behavior. As long as management doesn't do anything to diminish the culture of putting the customer first, Costco will maintain its industry standing.
The outlook for investors
Costco is a fantastic business. It's not a high-flying tech enterprise riding the artificial intelligence boom. It's a boring retailer that continues to reward its shareholders.
However, I believe investors should temper their expectations if we look at the next 10 years. Shares of this top-notch retailer are currently trading at a price-to-earnings (P/E) ratio of around 48. That's a significant premium to its past 10-year average of 33.6. Just in the last 12 months, that P/E multiple has expanded by 25%.
It's safe to say that this is a frothy valuation. The P/E ratio 10 years from now is totally unpredictable this far in advance, but let's just assume it reverts back to the mean of 33.6. This would create a 31% headwind for investors.
If diluted earnings per share rise at an 11.8% annualized rate between fiscal 2023 and fiscal 2033 -- the same pace they rose at in the preceding decade -- the stock would return just over 7% per year. The possibility of valuation compression is a powerful opposing force. That potential gain underperforms the S&P 500's long-running average of 10% annually.
Costco stock's 10-year forecast doesn't make this a no-brainer buying opportunity right now. But maybe practicing patience and waiting for a better entry valuation is the best move.
