Will the growth stock potentially increase by 50% in 2024, reaching a value of $1,000 per share, and continue to increase further in 2025?
Costco Challenges the Market (COST 0.80%) surpassed the $1,000 mark per share on December 11, setting a new record high and boosting its market capitalization beyond $440 billion. Costco's share price has skyrocketed this year, but its earnings growth isn't keeping pace. Costco now appears to be a growth stock, deviating from its traditional status as a value or dividend stock.
Let's delve into whether Costco justifies its growth stock premium, or if the risks outweigh the rewards.
An Impressive Business Strategy
Wholesale retail might not have the same allure as tech giants, but Costco has been a standout performer in recent years. Gaining 50% this year and 239% over the past five years, Costco has undeniably outshone its competitors.
Costco's product range covers both essentials and luxuries, including groceries and electronics. It also offers services in various sectors, such as car maintenance, insurance, and travel packages. From their iconic $1.50 hot dogs to gold bullion, to eyecare services from Costco Optical, Costco's diverse offering keeps customers returning and renewing memberships.
Costco's reputation is built on authenticity and transparency. In fiscal 2024, which concluded in September, Costco recorded $249.6 billion in sales and $7.4 billion in net income. Revenue from membership fees, amounting to almost pure profit, reached $4.8 billion, with the membership base expanding to 137 million cardholders, retaining 90% of them.
Costco's merchandise expenses for the year totaled $222.4 billion, resulting in a meager 10.9% gross margin. After accounting for sales, general, and administrative expenses of $22.81 billion, it's evident that Costco earns very little on its merchandise. Last fiscal year, Costco slightly increased membership fees, contributing to higher earnings growth than sales. This was the first fee hike in seven years, further emphasizing that Costco does not exploit its customers.
Costco is a quintessential long-term investment. Its focus is on maintaining its brand value and customer loyalty instead of boosting near-term profits by overpricing membership fees. Costco's consistency and clear business approach make it a reliable choice for long-term investors. Additionally, Costco occasionally rewards shareholders with extra dividends.
An Unique Passive Income Opportunity
Costco pays a relatively minimal, but steadily rising, ordinary dividend. Based solely on this dividend, Costco yields only 0.5%. However, Costco has historically rewarded investors with occasional special dividends when its cash reserves reach an optimal level. In late 2023, Costco declared a $15 per share special dividend.
Costco's special dividends have increased due to the company's growth. In December 2020, Costco distributed a $10 special dividend, a significant increase from the $5 per share special dividend in 2015. The graph below illustrates the relationship between Costco's cash position and its last four special dividend payments.
Given the current cash levels, it's unlikely that Costco will pay a special dividend for at least a year or two. However, some would argue that special dividends are an inefficient use of cash.
If the company had utilized that cash for stock buybacks instead of dividends, it would have improved the stock's value by reducing the number of outstanding shares. Stock buybacks avoid the "double taxation" issue associated with dividends, as the company pays taxes on earnings and investors pay taxes on dividend income in taxable investment accounts.
Since Costco has performed exceptionally well over the long term, utilizing its excess cash for stock buybacks would have been a better choice. Unfortunately, Costco's outstanding share count has remained relatively constant over the past decade, contributing to its inflated valuation.
Costco Commands a Premium Price Tag
Costco is an exceptional company, but its valuation has escalated from expensive to extreme in recent years. Despite only anticipating modest double-digit earnings growth in the near future, the stock carries a stratospherically high price-to-earnings (P/E) ratio of 58. As the following chart demonstrates, Costco's forward P/E remains far above historical levels. For comparison, the S&P 500's P/E ratio is 31.
Costco is Overpriced
Costco continues to provide excellent value for its members, but the value is missing for investors. Although Costco is consistent, it's not worth paying any price for the stock.
Costco would need to see a substantial decline in value before the pricing would become reasonable. It's a stock that's worth keeping an eye on, but it could undergo a significant correction if its valuation adjusts to reality in the new year.
In the context of strategic financial planning, it's important to consider Costco's potential for generating returns through investments. Despite its premium price tag, Costco's consistent growth and reliable dividends make it an appealing choice for long-term investors seeking to diversify their finance portfolio.
Given Costco's impressive financial performance and unique dividend strategy, prospective investors might want to explore opportunities for incorporating the stock into their finance plans, especially considering the potential returns from both ordinary and special dividends.
