5 reasons to own Costco despite premium valuation and near record high stock price

Published Wed, Feb 14 20243:21 PM ESTUpdated Wed, Feb 14 20243:26 PM EST

Wall Street analysts see multiyear growth potential for Costco — given its stellar business model and other idiosyncratic strengths. It's a view we share as economic and inflation data keep us guessing . BMO Capital Markets increased its Costco price target to $770 per share from $700 and kept its buy-equivalent outperform rating on the stock. In a note late Tuesday, the analysts cited all the things we love about the retailer from its recent special dividend to consistent traffic patterns to a possible membership fee hike that's historically overdue. BMO in the same dispatch hiked its price targets on big-box peers Walmart and Target . Costco was a top retail performer for 2023, with shares gaining 45% and outperforming the S & P 500 's 24% increase. The stock has gained 9% this year — roughly double the S & P 500's advance. After last week's release of solid January sales, Costco got a slew of price target raises. Costco on Wednesday was trading just below its all-time high of $728-and-change reached last Thursday. COST YTD mountain COST stock price year to date. Costco shares are high in price and also expensive on a valuation basis. ( Check out our commentary on 10 undervalued stocks .) The retailer trades at a price-to-earnings ratio of 43.8 times the next 12 months earnings estimates. That's higher than its 35.2 times five-year P/E average and near the high end of its historical range. BMO analysts said Costco is "deserving of its premium" valuation due to its "strong return on invested capital, industry-leading sales, and consistency of results and execution." The analysts listed five reasons for their bullish case on Costco: White space potential: Analysts see "another decade-plus of growth" at Costco given its "significant unit growth expansion potential both in the U.S. and internationally." Business model: BMO believes Costco has the "best business model in retail" because of its low general merchandise percentage on shelves and continued market share gains. Moat: Analysts argue Costco's low general merchandise percentage creates a strong moat since the company is "underearning relative to retail peers." Membership fee hike: Analysts expect to see a membership fee hike soon — something like $10 for the Executive and $5 for the Gold Star, which in the U.S. and Canada could mean roughly $340 million to $350 million in additional revenue and 50 to 60 cents worth of annualized earnings per share. Low theft: Costco is insulated from shrink (the retail industry's term unaccounted for inventory, typically from theft or shoplifting) due to its membership model and card checks at store entrances and receipt checks at exits. Shrink is an issue traditional retailers have suffered through recently. For this reason, Costco investors "may be willing to pay a higher multiple," analysts said. Other analysts on Wall Street tend to agree with BMO. Costco stock caught a series of analyst price target increases following last week's strong sales report for the retail month of January. Some of the highest price targets were Loop Capital's $800, up from $755 and UBS' $825, up from $725. Both firms maintained their buy-equivalent ratings on the stock. Costco said last Thursday that total comparable sales were up 2.7%, driven by healthy in-store traffic, solid e-commerce, and positive performance in non-food items. January had one less shopping day due to the timing of New Year's Day. Most categories were up including food and sundries and fresh foods. Investors were also encouraged to see non-foods or general merchandise continue to trend higher, with jewelry, tires, and health and beauty products rebounding. U.S. sales were up 1.6% and Canada was up 6.2%. (Sales from Mexico are not reported on a monthly basis.) Other International, or everywhere else Costco does business, was up 5.1%. Most of Costco's 874 locations, as of Tuesday, are in North America: more than 68% in the United States, 12% in Canada, and 4.5% in Mexico. The rest of the stores are on every continent except South America. Costco has six stores in China — including a new Shenzen location, which caused a mob scene on opening day last month. In a recent interview with CNBC, outgoing CFO Rich Galanti said, "We'd probably be at least fifty-fifty outside of the U.S. and Canada" in the next six to seven years, he said. Costco is "not saturated" domestically or internationally, he stressed. Costco plans to open one more China location this calendar year. The first Costco store in China opened roughly four years ago in the city of Shanghai. Galanti, who has been CFO of Costco for 40 years, is stepping down from his post and will be succeeded by Gary Millerchip, former CFO of Kroger, effective March 15. Galanti will remain in an advisory capacity on the company's board through January 2025. Costco is set to report its fiscal second quarter of 2024 on March 7 after the market close. Back in December , Costco's first quarter of its fiscal year 2024 came in better than expected, with beats on both the top and bottom lines. The results underscore that this best-in-class retailer can deliver consistent results in any type of economic environment. The strength of its warehouse membership model and ability to retain a loyal customer base should allow the company to continue expanding its footprint by opening new stores in the U.S. and internationally. (Jim Cramer's Charitable Trust is long COST. See here for a full list of the stocks.) 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