Costco Wholesale (COST +1.58%) fell 6.1% on Friday in response to its second-quarter fiscal 2025 results and management commentary on the earnings call. Costco's earnings only came in slightly below Wall Street analyst estimates. So the extent of the sell-off may seem a bit surprising, especially considering Costco isn't usually a volatile stock.
In fact, Costco hasn't fallen by over 6% in a session since Dec. 1, 2022, when it dropped 6.6%. But the stock has roughly doubled since then and has been a massive winner for long-term investors.
Here's why Costco stock tumbled, and if the dividend-paying growth stock is a buy now.
Image source: Getty Images.
Tariffs could negatively impact Costco
Stock price movements aside, Costco's results were excellent. Adjusted sales were up 8.6%, and e-commerce grew 22.2%.
Costco continues to achieve growth through strong comps on existing stores and new store openings. The company finished the quarter with 897 warehouses, 617 of which are in the U.S. and Puerto Rico. But 150 stores are in Canada and Mexico, which adds diversification to the business, but is also a near-term risk, given the trade war and tariff tensions.
Like any retailer, tariffs would impact Costco's supply chain and could strain margins. Costco was already seeing some weakness in consumer spending, especially in discretionary categories like electronics and apparel. But Costco said consumers are cooking more at home, which helped drive food sales.
No company is immune from industrywide challenges or cyclical downturns. So instead of overly focusing on whether tariffs could impact Costco's near-term results, the question to ask is whether Costco can handle tariffs better than its competition.
NASDAQ: COST
Key Data Points
Costco's recipe for success
On the earnings call, Costco CEO Ron Vachris said that less than half of U.S. sales are imported from China, Mexico, and Canada, adding some protection against tariffs. He also stated that Costco would try to minimize the impact of cost increases on its members. "In uncertain times, our members have historically placed even greater importance on the value of high-quality items at great prices," said Vachris on the call.
Costco's emphasis on building member trust is integral to its business model. If prices go up on consumer staples across the board, consumers may still feel the best way to make their dollars go far is at Costco.
Costco has always been transparent about its pricing model. By charging razor-thin margins on goods, merchandise, and services, Costco gives customers the best value and justifies why the annual membership is worth it.
In fiscal 2024, Costco had sales of $249.6 billion and operating income of $9.29 billion. But membership fees were $4.83 billion, which is basically pure profit. So although the overall operating margin was 3.7%, the operating income on merchandise sold was just $4.46 billion -- or 1.8%. This means that Costco is converting less than $0.02 from every dollar in sales into operating income.
Costco could easily raise prices and make billions more in operating income per year. But that would go against the company's long-term strategy and could impact the invaluable trust members put in the brand.
In fiscal 2024, Costco's base grew to 137 million cardholders, with a 90% renewal rate. And that's even considering Costco raised prices on membership fees for the first time in years.
In sum, Costco truly is offering consumers good value, and that strategy should prove even more effective in a period of escalating geopolitical tensions.
A shift to volume and value
Wholesale businesses like Costco, Walmart's Sam's Club, and BJ's Wholesale Club have been winning business models and stocks in recent years.
Costco has been growing faster than the competition, but unfortunately, that momentum is already reflected in its stock price. Over the last three years, Costco stock has more than doubled, while diluted EPS is only up 35%. Over the last decade, Costco stock is up a staggering 545%, while diluted EPS is up less than half of that.
Anytime a company's stock price outpaces earnings growth, its valuation will become more expensive. Costco's price-to-earnings (P/E) ratio has ballooned to 56.3 -- much higher than its 10-year median of 34.8 or even its five-year median P/E of 39.7. The stock is far more expensive than Walmart's 38 P/E and more than four times pricier than Target's mere 13 P/E.
Costco stock is too expensive
Costco arguably deserves one of the highest valuations of any retailer. Given its track record of execution and steadfast focus on long-term strategy, I'd expect Costco to perform better than the competition during times of uncertainty. However, the stock is simply too expensive to consider at this time.
What's more, Costco's dividend isn't attractive. The yield is just 0.5% -- hardly enough for passive income investors. And although Costco has been known to pay a special dividend every few years, the payout isn't substantial on a percentage basis. For example, Costco's last special dividend was $15 per share. Even when combining that special dividend with the ordinary dividend of $4.64, Costco would only yield around 2%.
If Costco's valuation ever fell to a more reasonable level, say around its 10-year median, there would be a strong case to buy the stock. But right now, the valuation is simply too far in the stratosphere to consider, even though Costco is probably the best-positioned retailer heading into a potential economic slowdown.
