Is Costco Stock a No-Brainer Buy?

Costco (COST -0.14%) has been a positive force in shareholder portfolios over the past few years. The warehouse retailer has thrived through every phase of the pandemic and its aftermath, first managing record customer traffic as shoppers stocked up on essentials and then seeing fantastic sales gains as revenue skyrocketed. Costco also endured less of a growth hangover than its peers during the post-restrictions period.

These victories highlight Costco's valuable competitive strengths, such as its price leadership, strong brand and excellent customer loyalty. Let's take a look at where these factors could take the stock over the next few years.

Membership measures

Costco is a retailer, which means investors will want to track same-store sales for signs that the company is on the right track. There is no reason to worry here. Sure, comps slowed in fiscal 2023. But the slowdown was modest (earnings fell to 3% from 5%), and a rebound is already underway. Pay rose 5% in the 22 weeks ended in early February, management recently announced.

Costco's long-term returns are correlated with its member metrics because the chain earns most of its revenue from subscription fees. It is important to note that its renewal rate continues to climb and has reached a record level.

In fact, 93% of members in the core US market renewed their subscriptions last year. This figure confirms that Costco offers tons of value to its members and that its profits will most likely continue to rise steadily. Costco reported operating income of $8.1 billion in fiscal 2023, up from $4.7 billion in 2019.

Disadvantages of stock

There are, however, a few factors that could put pressure on the stock over the next few years. Wall Street is excited about an upcoming increase in contributions, but may be disappointed to see the increase translate into a modest increase in profits.

Costco needs to get an increase here considering it's been more than five years since it last raised fees. But management tends to devote almost all of the additional cash resulting from these increases to lowering prices rather than increasing profitability.

Operating COST Margin (TTM) data by Y Charts

On the positive side, this approach means that shareholders do not have to endure the type of annual profit fluctuations that are common among retailers like Target. The downside is that Costco's profit margin tends to stay low, at around 3% of sales, even during boom times.

Investors may also be disappointed with the chain's cash returns in coming years. Costco does not commit to paying a generous annual dividend like Walmart does so, but returns most of its income in unpredictable and sporadic payments.

Price and value

Costco appears established as a preferred and frequent shopping destination for its growing pool of members. As a result, it is highly likely to set new sales and profit records in a few years, regardless of the consumer spending environment.

The big question is whether this success will translate into market-beating returns for patient investors. Stocks are unfortunately expensive. Costco shares are valued at 1.3 times annual sales, which is the highest premium in the last decade.

You can own Target for 0.6 times sales or Walmart for 0.7 times sales. Even Amazon That seems like a relative value at 3x sales, given its growing profitability and ample growth prospects.

Costco stock should continue to perform well relative to its retail peers thanks to its industry-leading growth and stable cash flows. But investors should temper their expectations for its near-term returns given the stock's high valuation today.

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Demitri Kalogeropoulos holds positions at Amazon and Costco Wholesale. The Motley Fool posts and recommends Amazon, Costco Wholesale, Target, and Walmart. The Motley Fool has a disclosure policy.

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