Some of the best-performing stocks don't have to come from the tech sector, and they certainly don't need to be exposed to the artificial intelligence boom. Costco (COST -1.32%) is the perfect example.
The world's third biggest retailer has produced a total return of 756% in the past decade, crushing the gains of both the S&P 500 and Nasdaq Composite Index by incredibly wide margins. This business currently carries a massive $363 billion market cap.
You might have your sights set on Costco as a potential investment opportunity. But is it too late to buy the stock?
Costco's compelling bull case
It's important to understand just how special a company this is. There are numerous reasons to believe that Costco should be in your portfolio as a long-term holding.
The business has historically registered consistently robust financial performance. Between fiscal 2013 and fiscal 2023 (ended Sept. 3 last year), Costco saw its net sales and diluted earnings per share rise at compound annual rates of 8.7% and 11.8%, respectively. There was not a single year during that stretch that the top line decreased, which is an impressive feat.
The company's strong profitability benefits shareholders. Management issues one-time special dividends, the latest being $15 per share last December.
Costco possesses a wide economic moat that protects its competitive position in an extremely cutthroat industry. Scale is perhaps the single most important factor contributing to the company's dominance.
With third-quarter 2024 net sales of $57 billion, Costco has unrivaled buying power. When negotiating with its vendor suppliers, the business can obtain favorable terms. These savings are always passed on to customers in the form of low product prices. It's a virtuous cycle that results in more revenue, which leads to even stronger buying power.
Speaking more about Costco's industry positioning, I'm convinced that the business faces a minimal threat of disruption. Amazon Prime is undoubtedly a top competitor, with its fast and free shipping on millions of items. However, the e-commerce titan's rise hasn't prevented Costco from continuing to report impressive financial performance.
Key to Costco's success is its membership-based model. People have to pay to be able to shop at the company's warehouses. This drives loyalty and repeat visits, any retailer's dream.
These memberships have proven pricing power. It was just announced that Costco would raise annual prices of the standard and executive plans by $5 and $10, respectively, in the U.S. and Canada. The last time management did this was in 2017, and since then, memberships have continued climbing, providing a rising high-margin revenue stream.
One key bear argument
If an investor took the time to understand Costco's operations, its moat, and its financial success, I'm certain that they would come away impressed. This is one of the world's best companies, and the stock's return indicates this.
However, that doesn't mean it lacks any bearish arguments. There's one obvious factor that simply can't be ignored. I'm talking about the valuation.
Shares currently trade at a price-to-earnings (P/E) ratio of 50. In the past decade, the stock has rarely traded at a higher valuation. In fact, Costco's average P/E multiple in the last 10 years is 35, so it's safe to say that the market has become overly optimistic about this business.
Paying such a steep P/E ratio might be justified if you believed that Costco was going to exhibit monster growth in the years ahead. But I don't think this is likely.
According to Wall Street consensus analyst estimates, Costco's revenue and diluted EPS are projected to increase at annualized rates of just 6.5% and 10.7% between fiscal 2023 and fiscal 2026. Paying 50 times earnings doesn't make sense based on this outlook.
Unless the valuation multiple contracts significantly, I believe it's too late to buy Costco stock.
