Costco Wholesale(NASDAQ: COST) and Home Depot(NYSE: HD) are two of the largest retailers on the planet. Since their respective initial public offerings in the 1980s, they have done a great job rewarding their shareholders, compounding capital over the very long term.
But which of these two retail stocks is the better one to buy right now? Let's take a closer look at each to come up with an informed conclusion.
The case for Costco
Costco is known for selling high-quality merchandise at very low prices, with a very generous customer-friendly return policy. On the surface, this doesn't help it stand out in the competitive retail sector. But what makes Costco special is its membership-based model. Only consumers who pay an annual fee have the right to shop at one of Costco's 861 warehouses.
In the latest fiscal year (ended Sept. 1), the business generated $4.8 billion in membership fee income. This provides the company with a high-margin, predictable, and recurring revenue stream. Even better, it drives customer loyalty. Households will prioritize shopping at Costco because they're already paying annual dues.
Costco has a very powerful and durable competitive strength in the retail sector. The company possesses scale advantages. With net sales totaling $78.2 billion in Q4, this is the world's third-biggest retailer. That huge figure, coupled with the fact that Costco sells a much lower number of stock-keeping units than competitors, gives it tremendous negotiating leverage with its suppliers. This leads to constantly low prices for consumers.
It's hard not to come away impressed with Costco's profitability. The business has increased its net income at a compound annual rate of 15% in the past five years. This affords the leadership team the ability to pay occasional special dividends, the most recent being $15 for each shareholder in January of this year.
The case for Home Depot
With trailing-12-month revenue of $152 billion, Home Depot is the world's leading home improvement retailer, well ahead of second-place Lowe's. It is a trusted brand with broad reach, as indicated by its network of over 2,000 stores scattered across the U.S. Plus, Home Depot's massive scale, with a developed supply chain and omnichannel capabilities, means it not only has a deep product assortment, but also has the ability to serve customers in ways most convenient for them.
There's no denying that Home Depot has struggled in the current macro landscape, one characterized by higher interest rates and consumer hesitancy to buy big-ticket items. Same-store sales are expected to drop 3% to 4% in the current fiscal year.
However, the business benefits from favorable industry tailwinds, like an aging housing stock and an ongoing housing inventory shortage. This should support durable demand for Home Depot over the long term.
It's also worth noting the company's attractive capital allocation policy. In fiscal 2023, Home Depot repurchased almost $8 billion worth of shares. And it paid out $8.4 billion in dividends.
Which is the better buy right now?
Home Depot might be in a more difficult spot than Costco, the latter of which seems to be humming along nicely regardless of the macro environment. However, the home improvement giant trades at a much more compelling valuation. Its stock can be purchased for a price-to-earnings (P/E) ratio of 27, less than half that of Costco's 57. In fact, Costco's steep P/E multiple has never been higher this century, a clear indication of the market's extreme optimism surrounding the warehouse club operator.
Investors who plan to buy and hold stocks with a three- to five-year time horizon will increase their chances of producing adequate returns by choosing Home Depot, in my opinion. I have confidence that its financial performance will revert back to historical trends. At the same time, Costco's high P/E ratio creates a major headwind for investment returns.
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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale and Home Depot. The Motley Fool recommends Lowe's Companies. The Motley Fool has a disclosure policy.
