Warehouse retailer Costco(NASDAQ: COST) is a very nice investment. The company ranks high on every investor’s checklist for business quality, from robust revenue growth and cash profits to excellent employee relations and social responsibility. But that’s Wall Street’s worst-kept secret, and Costco’s stock is trading at very high valuations today.
Today let’s look at two separate, but closely related questions. Could Costco stock last you a lifetime, and is now a good time to buy these top-quality stocks?
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If this document were a bundle of courtroom notes, there would be objections to directing the witness at this point. I’ve already made it clear that Costco runs a great company and its success benefits shareholders.
Top sales increased 65% over the past five years, while free cash flow doubled:
COST Revenue (TTM) data per YCharts.
The company’s gross profit margin has fluctuated over the years, but margins further down the income statement have shown consistent increases. In other words, Costco is collecting growing profits and cash flow while charging low prices at the warehouse checkout:
COST Gross profit margin data per YCharts.
Membership fees play a crucial role in this business model. These fees accounted for about 1.9% of Costco’s total revenue in fiscal 2024, but that’s an almost pure profit generator with minimal costs. As a result, fees generated more than half of Costco’s operating profit and 73% of its free cash flow last fiscal year.
Costco is known for paying a living wage with great benefits, resulting in a happier and more productive workforce. This company does almost everything right.
Again, Costco’s quality is no secret. The S&P500 has more than doubled in the past five years, while Costco advanced with a total return of 264%.
COST Revenue (TTM) data per YCharts.
As a result, Costco’s stock trades at a pricey 60 times trailing earnings and 66 times free cash flow. The shares look expensive next to the major retailers Walmart and downright expensive next to it Goal.
Retailer
Price/Earnings (TTM)
Price to turnover (TTM)
Price to Free Cash Flow (TTM)
1-year stock price change
Market capitalization (billions)
Costco
59.8
1.7
66.2
65%
$439
Walmart
38.5
1.1
44.3
87%
$473
Goal
14.4
0.6
13.7
0%
$62
Data collected from Finviz on 12/10/2024. Chart by author. TTM = after 12 months.
These ratios are enough to keep most value investors away from Costco’s stock right now.
Which brings me to the second and most important part of the original question: Is Now the Right Time to Buy Costco Stock?
With a few notable exceptions, I think it’s best to just hold the Costco stock you already own. The longer you own it, the harder you have to hold on to it.
Imagine buying some Costco stock 20 years ago, for $48 per share. You then got a modest 0.6% dividend yield, similar to the 0.5% yield that new Costco investors buy today.
However, the company regularly paid dividends of $4.50 per share over the past year, which equates to an effective yield of 9.4% on those twenty-year-old shares. It also offers a special profit-sharing bonus every three or four years – and the most recent was $15 per share in January 2024.
That is not an annual item, but in the last example the revenue has more than quadrupled. You won’t find a savings account with an annual interest rate at that level.
You might want to take a little Costco profit off the table by selling a few shares at today’s generous prices. That makes sense in the short term, given Costco’s market-losing returns in recent years — with a particularly market-crushing performance in 2024.
Remember, the market ebbs and flows, but Costco and other top stocks tend to float higher over time. Timing the market with opportunistic trades may sound like a good idea, but even master investor Warren Buffett can’t tell what the economy, the stock market, or any stock will do in the near future.
His wealth was based on having owned large businesses for a long time. And if you sell some or all of your market-beating Costco stock today, you won’t see any additional dividend effects in 20 years.
But even Buffett probably wouldn’t buy new Costco stock right now. You see, the Oracle of Omaha also prefers to buy a great company at a fair price. Costco currently only meets one of the two criteria, so it’s probably best to wait for a cooling-off period before building a Costco position from scratch.
In short, Costco stock can last you a lifetime if you have a long-term mindset, but it’s too expensive to buy today.
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*Stock Advisor returns December 9, 2024
Anders Bylund has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Costco Wholesale, Target, and Walmart. The Motley Fool has a disclosure policy.
Could Buying Costco Stock Today Save You a Lifetime? was originally published by The Motley Fool
