Should Costco Continue to Be Purchased at a Price of $1,000 per Share?
In the retail sector, Costco (COST -1.33%) has been one of the most successful long-term investments. A favorite of Warren Buffett's late partner, Charlie Munger, Costco's unique business strategy, affordable approach, and consistent growth even in challenging retail circumstances led to another successful year in 2024.
However, with the stock rising by an additional 50.8% in 2024 and Costco's share price recently reaching $1,000 per share, are shares still a good investment?
Costco's valuation appears high... initially
Let it be clear, Costco isn't an inexpensive stock. Shares currently cost an astounding 58 times earnings. Such a valuation is typically reserved for fast-growing technology companies, not established retail giants.
The high P/E ratio is due to Costco's revenue increasing by only 5% in the previous year. Analysts predict that revenue will increase by just 7% each of the next two years.
Even though mid-to-high single-digit growth is nothing to disregard, it does not seem to justify Costco's high valuation.
Yet earnings are increasing at a brisk pace
Despite modest revenue growth, Costco's earnings are increasing at a much faster pace, up by 17% during fiscal 2024.
The company is clearly generating significant operational efficiency and margin expansion. This could be due to Costco being a low-margin company to begin with, thanks to its membership business model and unwavering commitment to offering the lowest prices anywhere. With such thin margins, any small improvement can result in significant profit growth.
Remember, Costco is a membership club where customers pay a modest annual fee for access. The price of a standard Gold Star membership was recently increased from $60 to $65 - the first price increase in seven years. However, this is still a bargain, considering the extensive range of heavily discounted items Costco offers.
Costco relies heavily on its membership fees for profitability; in fiscal 2024, Costco's $4.8 billion in membership fees accounted for 52% of the company's $9.3 billion in operating income. This steady stream of membership fee income enables Costco to sell its merchandise at almost non-existent margins. In 2024, Costco had a mere 11% merchandise gross margin and a meager 1.8% merchandise operating margin.
That margin is extremely difficult for non-membership-based retailers to compete with, and it's also why Costco continues to attract more and more customers, generating operational leverage on its existing properties.
Operating with such low margins means even a minor increase in margins could result in a significant boost to profits. For instance, if profit margins increased from 1.8% to 1.9%, this would represent a 5.6% additional increase in profit growth on top of any growth in the company's top line.
As long as Costco continues to expand its store count, introduce new merchandise, attract more members, and generate same-store sales growth, profits should continue to grow at a higher rate than sales. Meanwhile, the July membership price increase should further boost profits in fiscal 2025.
Can Costco continue to grow as it has?
Costco recorded $250 billion in sales last year and has a market cap of $440 billion, which may leave some investors questioning whether it can continue to grow at a solid pace given its enormous size.
However, this perspective may be shortsighted. By the end of 2024, Costco will have 897 stores open. A significant 617 of these are in the United States, and 767 are located in North America.
This leaves plenty of room for growth internationally, and Costco is strategically expanding in many countries throughout Europe and Asia, where Costco remains largely underrepresented. Asia appears to be a particularly promising market; of the 29 stores opened in 2024, 23 were located in the United States and 6 were international. Of these 6, 5 were in East Asia, with two each in China and Japan, and one in South Korea.
China represents a potentially huge growth opportunity. Costco opened its first store in China in 2019 but has already expanded to seven stores. Given that China has four times the population of the United States and that Chinese consumers seem to be enthusiastically embracing Costco, it's easy to see Costco surpassing its number of stores in the United States in the long term.
Even in the United States, there are still growth opportunities. On the recent first quarter 2025 conference call with analysts, new CEO Rob Vachris highlighted the success of Costco's new Pleasanton, CA store. This store was recently opened near three high-volume stores in the East Bay, across from San Francisco. Vachris explained that the new store initially drew some customers away from the surrounding stores, but when those stores became less crowded, the shopping experience improved, and the stores soon regained their former clientele, resulting in additional revenue and profit.
Continue investing in Costco
I'm not saying Costco's stock couldn't experience a significant decline given its high valuation. However, for those with a long-term perspective, Costco still appears to be a high-quality stock that is worth considering investing in today - even at $1,000 per share.
With its robust business model and opportunities for both multi-decade growth and profit expansion, the stock does not appear as overpriced as it may seem at first glance.
Despite Costco's high P/E ratio of 58 times earnings, the company's earnings are increasing at a rapid pace of 17% during fiscal 2024. This growth is largely due to Costco's ability to generate operational efficiency and margin expansion, a result of its membership business model and commitment to offering the lowest prices. The high valuation might not seem justifiable with only 5% and 7% revenue growth predicted for the next two years, but Costco's reliance on membership fees for profitability and the potential for international expansion make it an appealing long-term investment for those with a patient perspective.
