When it comes to solid retail companies, investors may struggle to outpace the competition Costco (NASDAQ: COST). The warehouse giant’s stock continues to seemingly defy gravity. Despite increasingly strong arguments for the stock’s overvaluation, the stock has risen 50% in the past year.
Understandably, this situation has investors wondering how to move forward with Costco stock. Do the continued gains mean investors should buy because valuation no longer matters? And even if someone owns the stock, can a shareholder make a case for staying in the stock, or is the price so stratospheric that all investors should stay away? Given these possibilities, investors should take a closer look at retail stocks before making such decisions.
Despite the fierce competition in the retail industry, Costco has some clear advantages. Indeed, it must be competed with Amazonthat doesn’t have the overhead costs to maintain warehouse stores and has other businesses that could theoretically absorb the losses from retail operations.
Still, investors should keep in mind that even Amazon’s fulfillment centers come with overhead costs that offset much of that advantage. Additionally, Costco sells most items in bulk, giving it an additional opportunity to lower prices.
Additionally, Costco has sidestepped the cultural challenges that hinder the international growth of retailers such as Walmart And Home Depot. So while these retailers have little room to add locations, Costco has barely scratched the surface of its potential store growth, despite operating in 47 U.S. states and 14 countries.
Additionally, Costco has fostered strong customer loyalty. The membership renewal rate stands at 90% worldwide, and despite a recent increase in membership prices in the US, 93% of US Costco members choose to renew their memberships.
Unfortunately, such benefits don’t come cheap for investors. Growing buyer interest in the stock has pushed the price-to-earnings ratio to a near-record high of 57, making further share price gains less likely. Furthermore, the forward earnings multiple of 54 indicates that rising earnings will not significantly reduce the price-to-earnings ratio.
COST PE ratio data per YCharts
Furthermore, the financial performance doesn’t seem to justify the earnings multiple. In the first quarter of fiscal 2025 (ended November 24), total revenue of $62 billion increased 8% year over year. Looking more broadly, revenues rose 5% in fiscal 2024 (ending September 1), indicating a respectable but not excessive growth rate.
In the first fiscal year, net profit was $1.8 billion, up 13% as revenue from non-operating sources boosted the company’s bottom line. Still, that is down from the 17% increase in the 2024 budget year.
Looking ahead, analysts predict that sales will grow by 7% in the current fiscal year and by the same percentage in the next twelve-month period. Also considering the aforementioned price-to-earnings ratio of 57, its financial performance indicates that Costco stock is not a good buy.
Moreover, dividends are unlikely to help. Although the company is consistently increasing its payout, the annual payout of $4.64 per share equates to a dividend yield of less than 0.5%. This is well below the average of 1.2% S&P500.
Although Costco paid a special dividend of $15 per share last year, Costco would have to pay that every year to beat the averages. Unfortunately for investors, the previous special dividend of $10 per share occurred in 2020, probably not enough to make it an excellent income stock.
Furthermore, the stock is approaching a high enough level that investors might consider selling. It took much lower valuations to convince Warren Buffett’s team Berkshire Hathaway to close its long-held Costco position in 2020.
Although Buffett later described the move as “probably a mistake,” you could argue it was early rather than wrong, prompting more investors to sell the stock.
Under current conditions, investors should probably consider selling Costco stock.
Admittedly, Costco is one of the more solid retail operations around. At a lower valuation, one could make a case for holding Costco stock.
However, Costco’s growth is such that its earnings figures won’t decline significantly without a significant drop in stock prices, a move that seems likely if history is any guide. Furthermore, the dividend is probably not enough to keep investors hooked on income. While Costco’s business will likely continue to grow in the long term, it appears the stock is overdue for a significant pullback.
Consider the following before buying shares in Costco Wholesale:
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Will Healy holds positions at Berkshire Hathaway. The Motley Fool holds positions in and recommends Berkshire Hathaway, Costco Wholesale, Home Depot, and Walmart. The Motley Fool has a disclosure policy.
Costco Stock: Buy, Sell, or Hold? was originally published by The Motley Fool
