3 Key Facts About Costco to Consider Before Investing

Costco Wholesale (COST 0.10%) has gained immense popularity among both consumers and investors. Over the last decade, shares of this warehouse club operator have surged by 595%. When including dividends, the total return for investors is a remarkable 752% during the same time frame.

This outstanding performance may entice new investors to consider Costco stock, especially as its shares continue to reach new heights. However, there are three crucial aspects to understand before making a purchase.

1. Memberships are Essential

At first glance, Costco appears to be a standard retailer offering a wide range of products to consumers. The reality is that memberships play a critical role in the company's success. Customers pay annual fees to shop at Costco locations, which generates significant revenue for the business.

In fiscal 2024 (ending Sept. 1), Costco earned $4.8 billion from membership fees, reflecting a year-over-year increase of 5.4%. Because a large portion of Costco's operational expenses pertains to merchandise and corporate costs, the membership fees provide a high-margin income stream.

It is likely that most of this membership revenue contributes to the company's profits. Moreover, this income is predictable and consistent.

Costco members find substantial value in their memberships, as demonstrated by the company’s ability to raise annual dues over the years. Despite such increases in fees, Costco’s membership base has continued to grow, now boasting 76.2 million households.

This membership model fosters customer loyalty and repeat purchases. As a result, Costco has enjoyed steady growth in same-store sales, which is crucial for any retailer's success.

2. Competitive Scale

In fiscal 2024, Costco reported net sales of approximately $249.6 billion, positioning it as the third-largest retailer globally, trailing only Walmart and Amazon. This level of scale affords Costco a significant competitive edge.

Costco's warehouses typically stock around 4,000 different items, a fraction of the approximately 30,000 products offered by competing grocery stores. This limited selection allows Costco to buy larger quantities of a smaller range of products, thereby gaining considerable negotiating power with suppliers.

Thanks to favorable pricing agreements with vendors, Costco can consistently provide low prices to its customers. The company usually marks up its products by only 11%, which is less than other major retailers. This strategy can lead to increased sales revenue over time, further enhancing Costco's bargaining position in the market.

3. Valuation Considerations

Costco shares have significantly outperformed the broader S&P 500 index over the past decade. This outperformance can be attributed to consistently strong financial results, with both revenue and net income exhibiting gradual increases.

However, it is essential to note that the current valuation of Costco stock appears quite steep. At present, shares are trading at an elevated price-to-earnings (P/E) ratio of 60. Historically, this is the highest valuation Costco has ever experienced since becoming a publicly traded company.

Investing at such a high P/E ratio could be justified if the company were on the verge of a significant growth phase. Nonetheless, Costco is a mature business, and analysts project its earnings per share will increase at a compound annual rate of 11% over the next three years.

Costco is undoubtedly a strong company with lasting potential. However, the current high valuation is a major reason investors might want to hold off on purchasing its stock at this time.

John Mackey, former CEO of Whole Foods Market, which is now part of Amazon, serves on the board of directors for The Motley Fool. Neil Patel and his clients hold no position in any mentioned stocks. The Motley Fool recommends Amazon, Costco Wholesale, and Walmart. For more information, check their disclosure policy.

Costco, Investment, Stock