Costco (COST -0.81%) has been an incredibly successful investment historically. In the past 40 years, its shares have generated a total return of 28,560%. That means a $3,500 investment back then would be worth just over $1 million today, a fantastic outcome.
Is this dominant retail stock, which has already made long-term shareholders extremely wealthy, a millionaire-maker in the making for prospective investors?
Steady, predictable, durable
Investors seem to always gravitate toward tech enterprises that are operating at the cutting edge of a new trend. Historically, certain internet-related companies have crushed it for portfolios. But Costco, which runs warehouse clubs around the world, is far from that. I believe this is what makes it so special.
Costco has proven to be a steady, predictable, and durable business. That's an advantage. In a world that seems to constantly be changing, Costco continues doing what has always made it so successful.
On the surface, selling high-quality merchandise at extremely low prices doesn't seem like a lucrative business model -- and it really isn't. In fiscal 2024, Costco reported a gross margin of 10.9%. However, it has developed something truly unique in the sector.
It operates a membership-only system, where shoppers must pay annual fees for the right to enter a Costco warehouse. Membership income totaled $4.8 billion last fiscal year. As of Nov. 24, 2024, the company counted 77.4 million membership households, up 7.6% compared to 12 months before. Money brought in from memberships generates high margins and is recurring in nature.
What's more, Costco's focus on low prices, coupled with the fact that shoppers already pay to be members, drives loyalty and repeat visits. Any retailer dreams of this scenario.
Besides a compelling customer value proposition, Costco has staying power. Its scale, as demonstrated by fiscal 2024 net sales of $249.6 billion, gives it tremendous negotiating leverage over its suppliers. That leads to cost advantages that directly benefit shoppers.
This supports consistently higher profits over time. Costco's net income of $7.4 billion last fiscal year was 258% higher than a decade before, and it was 735% higher than 20 years prior in fiscal 2004. This has led not only to ongoing dividends, but sizable special one-time payouts for investors. It's hard to argue with Costco's durability.
It's remarkable what Costco has been able to do over the past few decades. The strategic playbook of catering to its customers' needs, supported by huge scale and a membership model, has led to outsized success -- and shareholders have been rewarded.
High expectations
Costco is undoubtedly a wonderful business. The problem is that everyone knows this to be true. Because of the company's financial success, particularly in the past few years, the market is overly bullish.
As of this writing, the stock trades at a price-to-earnings (P/E) ratio of 55. That's more than double the multiple of the overall S&P 500. In Costco's entire public history, it has rarely been more expensive than where it trades today.
Costco's durability, which I touched on earlier, is a key reason one might justify the high valuation. It's not difficult to make the argument that this business will still be relevant 50 years from now, still atop the retail sector. You can't say that about the vast majority of companies out there. That means there's minimal threat of disruption or obsolescence.
Bullish investors might also point to growth. But in the past decade, diluted earnings per share have climbed at a 13.5% annualized pace. Consensus analyst estimates call for 11.6% yearly growth over the next three years. Does that warrant paying 55 times net income for an ownership stake? I don't believe so.
The current P/E multiple leaves no margin of safety for new investors. If you buy shares right now, you're essentially betting that Costco's bottom line is going to register a growth spurt going forward. That doesn't look to be the case.
This stock has made millionaires in the past. Going forward, though, investors should have tempered expectations.
