Costco Wholesale (COST 3.25%) is one of the largest, most popular retail stocks to own. But investors may be growing concerned that its valuation has gotten too high. At more than $320 billion, its valuation can look pricey as the stock trades at close to 50 times its trailing earnings. Even for fast-growing tech stocks, that can look expensive. In retail, where growth is more modest, it can be much more concerning.
Costco's stock does appear to be losing steam of late, declining by 2% last month. But there's one thing that could quickly send the stock rallying again -- an increase to its membership fees.
NASDAQ: COST
Key Data Points
Is an increase to Costco's membership overdue?
A key reason Costco does well is that it relies on membership revenue to boost its margins. Those memberships can help it price items more aggressively, knowing that its margins can be a bit lower and that membership revenue will give its financials a boost.
During the 12-week period ending Feb. 18, the company generated $1.1 billion in revenue from its membership fees. While that's a relatively modest slice of the more than $58.4 billion it reported from its top line, it becomes much more important when you see how thin its margins are. At just under $2.1 billion for the quarter, Costco's operating income was only 3.5% of revenue. And that includes the effect of membership fees. Without those fees, Costco's margins would be even tighter, and it would make the stock look more expensive than it is today.
The last time Costco raised its membership fees was in 2017, when it increased the cost of its individual Goldstar membership by $5 to $60, and its executive membership by $10, to $120. On average, the company raises its fees every five to six years, which would suggest that it may only be a matter of time before Costco announces another rate increase to its membership.
An increase in its membership fees could go a long way in boosting its bottom line, especially as Costco continues to expand into new markets. Earlier this year, the company opened its sixth store in China, which still presents a huge growth opportunity for the business.
Why Costco might not increase its membership just yet
Costco may not feel the pressure to announce a price hike to its membership given how well it has been doing. In its last quarter, revenue rose by 5.7%. Comparable net sales for February (the four-week period ended March 4) were still up 5%.
The company has been a go-to option for consumers because of the value it offers. It hasn't increased the price of its hot dog despite rising inflation. Earlier this year, it also rewarded its shareholders with a generous $15 per share special dividend.
Investors and customers know that another membership hike is likely coming, and it's only a matter of when. But by not increasing its fees at a time when many other companies and retailers are eager to use inflation as a way to justify higher prices, Costco is again showing how it's different than its peers.
That's why I wouldn't be surprised if it puts off making an increase in its membership fees until interest rates come down, when there may be less of an effect on customers.
Should you buy the stock, even at its high valuation?
Costco's stock isn't cheap, but there are multiple catalysts that could strengthen its earnings power and, thus, bring down that multiple in the long run. One is an increase to its membership price, and the other is continued growth in international markets. The company's earnings still have a lot of room to grow. That's why this is a retail stock that can make for a good investment, provided that you're willing to buy and hold.
Its high valuation could prevent Costco's stock from rising a whole lot higher in the near term, but once it announces a price increase, that could quickly make investors bullish on the stock again. And in the bigger picture, with plenty of growth opportunities still out there for the business, the stock has the potential to generate significant returns for investors down the road.
