Warehouse-retailer Costco(NASDAQ: COST) is a really sweet investment. The company scores high on any investor’s checklist for business quality, from robust sales growth and cash profits to stellar employee relations and social responsibility. But that’s Wall Street’s worst-kept secret, and Costco’s stock is trading at very lofty valuations these days.
Let’s look at two separate but tightly related questions today. Could Costco’s stock set you up for life, and is today a good time to buy this top-quality stock?
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If this document were a bundle of courtroom notes, there would be objections about leading the witness at this point. I already made it clear that Costco runs a great business and that its success benefits shareholders.
Top-line sales rose by 65% in the last five years, while free cash flow doubled:
The company’s gross profit margin fluctuates over the years, but the margins further down the income statement show consistent increases. In other words, Costco collects growing bottom-line profits and cash flow while charging low prices at the warehouse checkout line:
Membership fees play a crucial role in this business model. Those fees accounted for about 1.9% of Costco’s total revenue in fiscal year 2024, but that’s a nearly pure profit source with minimal expenses. As a result, the fees produced more than half of Costco’s operating profit and 73% of free cash flow in the last fiscal year.
Costco is known for paying a living wage with great employee benefits, which results in a happier and more productive workforce. This company is doing pretty much everything right.
Again, Costco’s quality is no secret. The S&P 500 more than doubled in the last five years while Costco steamed ahead with a total return of 264%.
As a result, Costco’s stock trades at a pricey 60 times trailing earnings and 66 times free cash flow. The shares look costly next to big-box retailer Walmart and downright expensive next to Target.
Retailer
Price to Earnings (TTM)
Price to Sales (TTM)
Price to Free Cash Flow (TTM)
1-Year Stock Price Change
Market Cap (Billions)
Costco
59.8
1.7
66.2
65%
$439
Walmart
38.5
1.1
44.3
87%
$473
Target
14.4
0.6
13.7
0%
$62
Data collected from Finviz on 12/10/2024. Chart by author. TTM = trailing 12 months.
These ratios are enough to keep most value investors away from Costco’s stock at the moment.
That brings me to the second and most important part of the original question: Is this the right time to buy Costco stock?
With a couple of notable exceptions, I think it’s best to simply hold any Costco shares you already own. The longer you’ve owned it, the harder you should hang on to it.
Imagine buying some Costco stock 20 years ago, for $48 per share. You got a modest dividend yield of 0.6% back then, similar to the 0.5% yield new Costco investors buy into today.
However, the company paid regular dividends of $4.50 per share over the last year, which works out to an effective yield of 9.4% on those 20-year-old shares. It also offers a special profit-sharing payout once every three or four years — and the most recent one amounted to $15 per share in January 2024.
That’s not an annual item, but the yield more than quadrupled in the latest example. You won’t find a savings account with annual interest rates on that level.
You might want to take a bit of Costco profits off the table by selling a few shares at today’s generous prices. That makes sense in the short term, given Costco’s market-beating returns in recent years — with a particularly market-stomping performance in 2024.
Just remember that the market ebbs and flows, but Costco and other top-notch stocks tend to float higher over time. Timing the market with opportunistic trades may sound like a good idea, but even master investor Warren Buffett can’t say what the economy, the stock market, or any particular stock will do in the near future.
His wealth was built on owning great businesses for a very long time. And if you sell some or all of your market-beating Costco shares today, you won’t see any supercharged dividend effects 20 years down the road.
But even Buffett probably wouldn’t buy new Costco shares at the moment. You see, the Oracle of Omaha also prefers buying a wonderful business at a fair price. Costco only meets one of the two criteria today, so it’s probably best to wait for a cool down before building a brand new Costco position.
In summation, Costco stock could set you up for life if you have a long-term mindset, but it’s too pricey to buy today.
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Anders Bylund has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale, Target, and Walmart. The Motley Fool has a disclosure policy.
