Costco Wholesale’s stock has become the Palantir Technologies of the retail world, boasting a steep valuation and an ardent investor base.
The warehouse giant continues to deliver value to its 77 million members worldwide with unbeatable deals like $4.99 rotisserie chickens and a $1.50 hot dog and soda combo—unchanged for 40 years.
This loyalty has propelled the company’s stock nearly 600-fold since its 1985 IPO.
However, its current valuation raises critical questions for investors.
Costco’s shares have surged 45% in 2024, reaching $962 and trading at 53 times forward earnings—levels only rivalled by Tesla among the S&P 500’s top 20 companies.
Yet, analysts warn in a Barron’s report that such lofty multiples may not align with Costco’s projected growth, which is expected to average 10% annually in earnings per share over the coming years.
Bull case for COST and merits of its business model
Despite valuation concerns, Costco’s model remains a favourite among analysts and consumers alike.
Costco’s revenue is expected to rise by 7% in the current fiscal year, following a similar gain in 2024.
Same-store sales have grown between 5% and 6% annually over the past two years.
Additionally, Costco’s nearly 900 stores—616 in the US—are expanding by 25 to 30 annually, reflecting strong demand for its value-oriented approach.
JPMorgan analyst Christopher Horvers praises Costco’s international expansion, noting its success in every country it has entered.
Approximately a third of its stores are overseas, and new locations often draw long lines, demonstrating the brand’s universal appeal.
Source: Barron’s
Morgan Stanley’s Simeon Gutman shares this optimism, forecasting accelerated profit growth.
He maintains an Overweight rating with a $1,150 price target, implying nearly 20% upside from current levels.
Membership fees play a pivotal role in Costco’s success, accounting for about half of its operating profits.
A $5 increase in the annual membership fee to $65 in September 2024—the first hike in seven years—further underscores its resilience.
Notably, nearly half of members opt for the $130 Executive Membership.
These fees, with renewal rates exceeding 90%, provide a steady income stream, giving Costco a Netflix-like appeal, and justify the outsize P/E multiple the company enjoys, bulls say.
Costco’s high valuation difficult to justify, analysts suggest caution
Brian Yarbrough, a retail analyst at Edward Jones, highlights that Costco was valued at 40 times forward earnings at the beginning of 2024 and 30 times prior to the Covid-19 pandemic.
This suggests the stock might lose momentum as earnings align with its current price—or potentially decline by 15% to 20% in the event of a market downturn or an unforeseen profit or revenue shortfall.
He says,
Costco is one of the highest-quality retailers in the industry, but it’s extremely difficult to justify the valuation of the stock.
If the stock reverts to a more modest valuation of 40 times projected 2025 earnings, its price could drop by over 20% to $725.
Costco’s stock comparison with other tech giants, Source: Barron’s
Even among its peers, Costco appears overpriced.
Growth stocks like Apple, Microsoft, and Nvidia trade at around 30 times forward earnings, while Walmart and Amazon hover at 35 times.
Costco’s price-to-earnings-to-growth (PEG) ratio of five starkly contrasts with the two-to-three range seen in most growth stocks.
Trivariate Research analysts share a cautious outlook.
Their data indicates that companies breaching a 50 P/E ratio for the first time often revert below 40 within a year, underperforming the market in the subsequent three years. They say,
While we can certainly appreciate many merits of Costco’s unique business model, it strikes us as a lofty increase in valuation for a business whose top-line growth isn’t materially different than it has been historically.
This view is echoed by Yarbrough, who stresses that Costco’s high-quality reputation doesn’t justify its elevated stock price.
“It’s going to be hard for the stock to outperform over the next three to four years,” he says.
Growing pains: limited US expansion potential
While Costco continues to thrive, its growth trajectory faces challenges.
Bill Smead, manager of the Smead Value Fund, highlights that Costco’s massive $250 billion in annual sales makes it mathematically difficult to sustain past growth rates.
The company still finds success in opening new stores in established markets, such as Pleasanton, California, and new territories like Scarborough, Maine.
However, the runway for US expansion is narrowing.
CEO Ron Vachris remains optimistic, citing opportunities in untapped domestic and international markets, but analysts like Smead compare Costco’s current valuation to the “Nifty Fifty” stocks of the 1970s, which significantly underperformed over the following decade.
Risks of a pullback and whether you should sell the stock?
History shows that steep valuations often invite corrections, and Costco’s case is no exception.
Analysts at Trivariate Research caution that companies with high P/E ratios frequently underperform over the long term.
While there’s no immediate threat to Costco’s fundamentals, a broader market selloff or unexpected earnings miss could trigger a sharp decline.
Moreover, valuing membership fees separately from retail profits—a common argument among bulls—remains controversial.
Yarbrough contends that Costco’s holistic strategy makes such distinctions impractical.
Costco’s strengths are undeniable, from its membership-driven model to its unwavering commitment to value.
Its loyal customer base, low shoplifting rates, and seasoned management team are testaments to its operational excellence.
However, the stock’s valuation appears stretched, especially in the context of its modest growth projections.
For long-term investors, the question isn’t Costco’s quality but whether its current price justifies future returns.
With risks of a pullback looming, now might be the time for investors to reassess their positions.
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