Wholesale Costco ( COST -0.12% ) may not be the most talked about stock on Wall Street, but it’s definitely a company every investor should want to know about. The retail juggernaut had an absolute tear last year, returning 63% to its shareholders compared to the S&P 500’s 8% rise over the same period. The company’s stock hasn’t been left out over the long term either – Costco shares have rewarded investors with a 291% gain over the past five years, equating to an average annualized return of 58% .
Consistent past performance is always a plus; however, as long-term investors, we should focus more on what a business will look like years from now. Costco continues to impress financially, but there are several downsides investors should be aware of before buying the stock. On that note, let’s look at Costco’s bullish and bearish cases to help you decide if the company is worth your investment today.
What the bulls say
Costco has plenty to brag about, but let’s start with its outstanding financial statements. In its most recent quarter, the company generated revenue of $51.9 billion and earnings per share (EPS) of $2.92, resulting in 16% growth and 36% year to year, respectively. Considering its colossal size, it is an extremely impressive growth.
Also, I don’t think you can get much better than Costco’s track record. In the second quarter of fiscal 2022, the company’s cash position of $11.8 billion exceeded its debt by $9.2 billion. With a debt ratio of just 46%, Costco is well positioned to weather any economic storm. And then there’s the cash, which Costco continues to easily generate. Over the past three years, the Company’s free cash flow and operating cash flow have grown at compound annual rates of 24% and 16%, respectively.
In such an unpredictable market today, Costco is as stable an investment as possible. The company’s membership model guarantees consistent profits and paints a transparent picture for investors looking to forecast the company’s future. Although only 2% of total revenue in 2021, membership fees accounted for more than 75% of net profits. And provided Costco’s membership turnover rate is 91%, investors can comfortably rely on the company reporting strong earnings.
Kirkland Signature, the company’s house brand, also makes life easier at Costco. Last year, Kirkland’s sales topped $59 billion, or 30% of total revenue. Think about it – not only did Costco’s private label generate three and a half times more revenue than its close competitor Wholesale BJ’s (BJ -1.00% ), it represents almost a third of the company’s total activity. This gives Costco immense pricing power and keeps it committed to low, competitive pricing.
What bears say
There is no doubt that the bears are talking about the valuation of Costco. Costco is trading at 48 times earnings, which is extremely high compared to peers such as BJ’s Wholesale, walmart (WMT -0.09% ), Kroger (KR -0.03% )and Target (TGT 1.45% ). Looking at the chart below, you’ll notice that Costco’s P/E is twice the median of its close industry peers.
Provided analysts are only modeling 7% and 10% average annualized growth in revenue and earnings through 2025, Costco’s valuation looks high. Costco has historically traded at a premium to the competition, but even so, the company’s current P/E multiple is well above its five-year average of 36. Investors will have to decide for themselves if Costco is worth it. to pay the price at current levels.
What I am saying
Costco is a great company – it’s as simple as that. In my eyes, however, that doesn’t make it a wise investment today. I’ve always thought Costco deserved to trade at a premium over most of its peers. The company’s membership model and pricing power have helped it establish a solid economic moat that is worth paying a higher price.
But like many things in life, enough is enough. Costco’s valuation got out of hand last year, and I can’t justify buying the stock today. Long-term shareholders should feel comfortable with their positions, but interested buyers should probably stay on the sidelines for now. Wait for this stock to experience a pullback, then consider buying stocks.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.