Inflation may have cooled off from its peak of around 9% in 2022, but the beast has not been fully tamed.
The Federal Reserve is aiming for a 2% inflation rate, and the central bank has resisted lowering interest rates further until it sees evidence that inflation will reach its goal of 2%. That could become more difficult as a new round of tariffs is set to be implemented after President Donald Trump's Aug. 1 deadline passed with some nations, like Canada, receiving rate hikes.
As of June, the consumer price index was 2.7%, while core CPI, which strips out the volatile food and energy categories, held at 2.9%, according to research from The Motley Fool.
The inflation rate holds implications for the stock market as a whole and for nearly every sector within it. However, few are affected as much as the retail industry. Consumer prices directly affect demand, and higher prices can drive away consumer spending, especially in discretionary categories. Alternatively, some retailers and consumer packaged goods companies can use inflation to pass along higher prices, expanding their profit margins.
One popular retailer to watch with inflation still volatile is Costco Wholesale (COST 2.42%), one of the world's biggest retailers by revenue.
Image source: Getty Images.
How inflation is affecting Costco
Costco's differentiated business model helps protect the retailer from inflation in some ways. First, because of its membership model, Costco's business isn't as sensitive to consumer prices as peers like Walmart and Target might be.
In fact, the company makes a large percentage of its profit from membership income. Its customers pay a base price of $65 a year for the privilege of buying its bulk goods at near cost. The profit it makes from retail sales is comparable to what it makes from membership income. In its most recent quarter, for example, it generated $1.24 billion in membership income, which made up nearly half of its $2.53 billion in operating income.
Since Costco enjoys a substantial membership-based revenue stream, inflation is less of a risk for the company as that membership income should be protected from inflation. Additionally, its customers have already paid to be able to shop there in part because of Costco's low prices.
Costco's pricing strategy, which is made up of selling bulk goods near cost and private-labeling brand-name products under its Kirkland label, arguably gives the company an advantage in an inflationary environment. Because of Costco's reputation for low prices, price-conscious consumers may be more likely to shop there when they're worried about high prices at other retailers.
In its annual report, Costco acknowledged: "Inflationary factors such as increases in merchandise costs may adversely affect our business, financial condition, and results of operations. We may not be able to adjust prices to sufficiently offset the effect of cost increases without negatively impacting consumer demand."
Is Costco a buy if inflation goes up?
Based on its membership model, reputation for low prices, and economies of scale, Costco seems better positioned than most retailers in an inflationary environment.
Looking back at 2022 could offer a good example of Costco's performance in an inflationary environment. In that year, Costco's performance essentially matched the S&P 500, with the stock falling 19.6% against the S&P 500's decline of 19.4%.
However, in fiscal 2022, which ended on Aug. 28, 2022, Costco posted impressive comparable sales growth, up 10.6% after adjustments for foreign currency and fuel prices. Earnings per share also rose 17% that year. Costco's results were similarly strong in the fourth quarter of 2022, even when inflation was peaking, with adjusted comparable sales up 10.4%.
This offers some evidence that Costco's business should be able to thrive in an inflationary environment. However, the stock could face pressure if the broad market pulls back, as it already trades at a high price-to-earnings ratio of 54, and expensive stocks tend to get hit harder in market sell-offs.
Given that valuation, Costco seems likely to follow the broad market lower on any macroeconomic worries. However, investors should rest assured that the business is resilient enough to handle another spike in inflation.
