It's hard to find a more reliable market-beating stock than Costco Wholesale(NASDAQ: COST). It hasn't delivered the wildest gains, but it has climbed up steadily and without fanfare in an almost linear progression, missing the ups and downs of a typical stock trajectory.
Even after rising 42% this year and hitting highs that make its valuation look enormous, it's not showing any signs of slowing down. Here's why, and why Costco stock deserves a place in your portfolio.
Costco just raised its membership fee
The beauty and endurance of the Costco model comes down to the membership system. Costco has a completely different model than most retailers, and several parts of it work together to create a differentiated system that's hard to beat. Costco isn't the only player in this field, with competitors like BJ's and Walmart's Sam's Club. But it's the biggest, with the most stores and the highest membership.
The main factor is the low prices, and everything else follows. Costco is a rare company that actually touts its low gross margins -- instead of trying to expand its margins, it keeps them as low as possible, marking up prices just enough to cover the cost of goods and associated expenses. That's why Costco's stores are unadorned warehouses, with products still on their pallets.
So how does the company make a profit? From the membership fees that it charges, which were recently raised to $65 annually for a basic membership and $130 for an executive membership. There are countless articles and blog posts out there demonstrating how worthwhile the membership fee is for most people, so long as you shop enough at Costco. That generates loyalty and volume for Costco and savings for shoppers.
Management had waited past its average time for a fee hike because it felt that consumers were already pressured, and it had enough going for it without the extra cash. As inflation moderates, it's planning to use the proceeds from the fee raise to pump extra value back through its stores to shoppers.
Membership keeps rising
An extra $5 isn't going to keep most members away, although Costco has yet to release an update on membership since the increase went into effect. Its most recent quarterly update is for the 2024 fiscal fourth quarter (ended Sept. 1), and membership increased 7.3% year over year. Renewal rates were 92.9% in the U.S. and Canada and 90.5% globally. Executive members increased 9.6% and represented 46.5% of the total, but they accounted for 73.5% of sales.
Management pointed out that membership has been trending younger since the pandemic started, and half of the new signups in the fourth quarter were under age 40. That's a great long-term growth driver as this population ages and shops at Costco.
Costco continues to open new stores at a steady rate, with 30 in fiscal 2024 and another 29 planned for fiscal 2025. It's taking off in international locations, and it has a long pipeline of new stores in plans.
How high can Costco Go?
Costco stock has historically traded at a premium to its peers, but it's entered new territory over the past few months and currently trades at a P/E ratio of 56, a major premium to its five-year average of 41.
In general, you don't want to buy a stock when it's trading at a high valuation relative to industry peers or average. That's ABC investing. Investors often do, though, for various reasons. A company might be growing much faster than its competitors or have an edge in technology that gives it a long growth runway.
In Costco's case, it has demonstrated over the past few years that it can achieve under adverse circumstances. Investors are willing to pay more for its reliable, steady growth. Also, when I talk about competitors, keep in mind that Costco stands in a category by itself.
At this valuation, there isn't too much room for error. But Costco doesn't make too many errors, and investors keep rewarding it, regardless of how expensive it has become. New investors might want to wait for a better entry point, but it may not get much better than this. Costco stock may be worth a premium price.
You can't time the market, so if you have a long-term horizon and can envision where Costco stock could be in a few years from now, you can buy even at the current price.
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Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale and Walmart. The Motley Fool has a disclosure policy.
