Costco Wholesale (COST -1.72%) passed $1,000 a share on Dec. 11, reaching a new all-time high and pushing its market capitalization past $440 billion. Costco's stock price is up big this year, but its earnings aren't growing that quickly. Costco's valuation now resembles a growth stock, not a value or dividend stock.
Let's determine whether Costco is worth its growth stock premium, or if the risks outweigh the potential reward.
Image source: Getty Images.
A near-perfect business model
Wholesale retail may lack the glitz and glam of highly innovative tech companies. But Costco has been every bit of a snazzy stock in recent years, gaining 50% year to date and 239% over the last five years.
Costco has an excellent product lineup that includes staples and discretionary goods. It also has service offerings in several categories, including auto services, life insurance, vacation packages, and more. From $1.50 hot dogs to gold bars to eyecare from Costco Optical, Costco's diverse product and service offering is what keeps customers coming back and renewing their memberships.
Costco's brand is centered around authenticity and transparency. The company has a well-deserved reputation for passing along value to customers. In fiscal 2024, which ended Sept. 1, Costco generated $249.6 billion in sales and $7.4 billion in net income. Revenue from membership fees, which is essentially all profit, was $4.8 billion, with the membership base growing to 137 million cardholders with a 90% renewal rate.
The company's merchandise costs were $222.4 billion for the year, giving the company a gross margin of just 10.9%. Add in sales, general, and administrative expenses of $22.81 billion, and it becomes clear just how little Costco makes on its merchandise. Costco raised membership fees slightly last fiscal year, contributing to higher earnings growth than sales. But it was the first fee increase in seven years. So Costco is practicing what it preaches and not overcharging.
Costco is the ultimate long-term-focused company. It chooses to sustain its brand value and customer loyalty rather than boosting near-term profits by overly raising prices of membership fees. Costco's consistency and clear vision for operating the business make it a company that long-term investors can count on. Costco also directly rewards shareholders with occasional special dividends.
A unique passive income opportunity
The retailer pays a rather small (but steadily increasing) ordinary dividend. Based on that ordinary payout alone, Costco only yields 0.5%. But Costco has historically rewarded investors with occasional special dividends when its cash position reaches a comfortable level. In late 2023, Costco announced a $15 per share special dividend.
Costco's special dividends have been increasing because the business has been growing. In December 2020, Costco paid a $10 special dividend compared to a $7 per share special dividend in 2017 and a $5 per share special dividend in 2015. The following chart shows the relationship between Costco's cash position and its last four special dividend payments.
COST Cash and Equivalents (Quarterly) data by YCharts.
Given where the current cash position is, Costco is unlikely to pay a special dividend for at least another year or two. What's more, the special dividend is arguably a bad way to allocate cash.
If the company used that cash to buy back stock instead of paying dividends, it would make the stock a better value by reducing the outstanding share count and avoiding the "double taxation" issue with dividends. Dividends are double taxed because a company must pay taxes on its earnings, and then when it passes along a portion of those earnings to investors through dividends, investors must pay taxes on that dividend income (in taxable investment accounts).
Since Costco has been such a market-outperforming stock over the long term, using excess cash on stock buybacks would have been a better move. Since Costco didn't do that, its outstanding share count has remained mostly flat over the last decade -- contributing to its over-extended valuation.
Costco demands a premium price tag
Costco is a phenomenal company, but the valuation has gone from expensive to lofty to nosebleed in recent years. Costco is only expected to grow earnings by high single digits over the next few years. Yet, the stock fetches a stratospherically high price-to-earnings (P/E) ratio of 58. As you can see in the following chart, Costco's forward P/E is still way above historical levels. For context, the P/E ratio of the S&P 500 is 31.
COST PE Ratio data by YCharts.
Costco is too expensive
Costco continues to provide excellent value for its members, but the value just isn't there for investors. The company is as consistent as it gets, but that doesn't mean it's worth paying any price for Costco.
Costco would have to sell off by a considerable amount before the valuation would make sense. It's a stock that's worth keeping on a watchlist, but it could see a major correction if its valuation comes back down to earth in the new year.
