Costco's Strong Growth Continues. But Is the Stock Too Expensive?

As usual, there's really nothing to complain about in Costco Wholesale's (NASDAQ: COST) latest quarterly results. The business keeps doing what shareholders have come to expect: generating steady comparable-sales growth, growing membership income, gaining digital momentum, and expanding its store count. The report once again shows that it remains a best-in-class retailer -- and maybe even one of the best businesses in the world.

But liking the business is not the same as liking the stock. While the former remains easy, the latter requires a leap of faith. The problem, of course, is price. Costco can keep executing well and still be a disappointing investment from this price if the lofty valuation gets rerated lower. And with shares near $1,000 again, investors should take this risk seriously.

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Looking at Costco stock's valuation

As of this writing, Costco stock trades at about 51 times earnings. That is a very rich valuation for a retailer -- even one as impressive as Costco. In fact, it's a pricey valuation for any stock.

To justify that kind of multiple, Costco likely needs to keep doing almost everything right: maintain healthy comparable-sales growth, keep membership income rising nicely, continue gaining traction digitally, and avoid any meaningful slowdown in store traffic or average customer transaction size.

In other words, the bar is high.

And that is exactly the problem. When a stock trades at this sort of premium, investors are not just paying for a great business. They are paying for years of continued excellence with little friction. There is very little room for risks, and there are plenty. To name a handful, risks include a softer consumer environment, supply chain disruption, new competition (imagine if Amazon ever decides to open a wholesale retail store), or even just a stretch of merely good -- instead of exceptional -- execution.

This is not to say Costco is wildly overvalued. But is it trading low enough to make it a buy? Probably not.

The bull case

With this said, Costco's latest results only helped the bull case, offering a reminder of why the market is willing to pay such a premium in the first place. Costco's results were strong across the board.

The company's fiscal second-quarter net sales rose 9.1% year over year to $68.2 billion. Comparable sales, or sales at stores open for more than a year, rose 7.4% year over year, or 6.7% when adjusted to exclude the impacts of changes in gasoline prices and foreign exchange.

Showing its momentum online, Costco's digitally enabled comparable sales increased 22.6%.

And profitability remained strong. Costco's net income climbed to $2.04 billion, or $4.58 per diluted share, up from $1.79 billion, or $4.02 per diluted share, in the year-ago period. This translated to year-over-year earnings-per-share growth of about 14%.

Importantly, Costco's membership fee income rose 13.6% year over year to $1.36 billion. And management said about one-third of that growth came from a membership fee increase it started rolling out at the end of 2024. Excluding the fee increase and foreign exchange, membership-fee income still grew 7.5%.

And the company carried that momentum into February. Alongside its quarterly update, management provided a sales update on its most recent retail month, which aligned closely with February. Net sales for the four-week period rose 9.5% year over year, while adjusted comparable sales increased 7% and adjusted digitally enabled sales rose 20.8%.

What should investors do?

Clearly, the business continues to fire on all cylinders. But does the stock really deserve to trade at a price-to-earnings ratio of 51? Probably not.

With that said, the company's impressive results and its strong February sales update arguably make a good case for holding onto the stock -- especially if selling would result in capital gains. But, despite this strong performance, I don't believe buying at this price makes sense. There's just no margin of safety for potential scenarios in which things go worse-than-planned or if the market decides to rerate the valuation lower, even as the business continues to execute.

Daniel Sparks and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale. The Motley Fool has a disclosure policy.