You don't have to own a high-flying technology business to achieve magnificent returns in the stock market. Even boring retailers can boost your portfolio. That's certainly true for Costco Wholesale (COST 1.01%). Shares of the popular warehouse store operator are up 219% just in the past five years.
Looking ahead, can this phenomenal retail stock double your money in the next five years? Here's what investors should be thinking about right now.
Costco is a fantastic business
If we just look at Costco's underlying business, it's almost impossible not to come away impressed. There are numerous factors that make this one of the world's top companies. With fiscal 2023 net sales of $238 billion, Costco is currently the third-biggest retailer on the face of the planet. Its size gives it tremendous scale advantages.
The business is able to negotiate favorable pricing when buying merchandise from vendors. Unless a supplier wants to lose out on a massive customer base, it has no choice but to do business with Costco. These savings are passed on to consumers in the form of low prices. The typical markup at a Costco warehouse is just 11%, much lower than other large retailers.
But low prices don't mean that this company isn't profitable. In fact, Costco generated operating income of $2.1 billion in the latest fiscal quarter (Q2 2024, ended Feb 18).
To be fair, that looks low. But when you're dealing with the massive amounts of revenue that Costco has, it leads to a large bottom line. Even more impressive, the operating margin has steadily expanded over the past 10 years. Because Costco is able to consistently increase its same-store sales, it can better leverage fixed costs.
Costco does a wonderful job at taking care of its customers. That means extremely low prices on high-quality merchandise, in a wide range of product categories, all in a compelling shopping environment. Having happy and well-compensated employees also helps in this regard.
Customers are also extremely loyal. Besides low prices, shoppers are encouraged to visit Costco locations frequently because of the company's membership business model. People must pay annual fees to shop at a Costco store, which drives repeat purchase behavior. Just in the U.S. and Canada, memberships had a 92.9% renewal rate last quarter, demonstrating their popularity.
This is already a truly massive corporation, but Costco still has some growth potential. Management opened 23 net new warehouses in fiscal 2023, with 28 planned to be opened in the current fiscal year. China is a big focal point, where Costco has only six warehouses today. Tapping into a huge middle-class population can drive further revenue and earnings gains.
Costco shares are extremely expensive
Given all these positive factors, it's not too surprising that Costco shares have soared in recent years. But investors have to set realistic expectations. As of this writing, the stock trades at a price-to-earnings (P/E) ratio of about 49. That's a substantial premium to the S&P 500, and it's significantly higher than Costco's trailing-10-year average of 33.8. You could say the shares are priced for perfection right now, leaving investors with no margin of safety.
That valuation might be justified if Costco experienced an acceleration in revenue and earnings growth over the next five years. But this is a mature enterprise these days. There's still growth to be had, but not as much as when Costco was a much smaller operation. Naturally, as it expands, opportunities will dwindle over time.
I think there's a high probability that Costco's P/E multiple will also shrink over the next five years. That makes me believe the stock won't double your capital between now and March 2029. In fact, wouldn't be surprised if shares underperform the overall market.
