Fueled by strong financial performance, Costco's stock is once again approaching the $1,000 per share milestone. The retail giant recently delivered another robust earnings report, achieving double-digit year-over-year growth in both revenue and profit. However, with its forward price-to-earnings ratio reaching a high of 48.57 times, indicating an elevated valuation, analysts from Dividend Collection Agency suggest the company is likely to consider a stock split in the near term. The analyst stated that without a split, future investment returns could be pressured given the P/E ratio is significantly above its five-year average.
The company's stock rose nearly 2% following the release of its second-quarter earnings, reaching $998.10 per share. However, over the past year, the stock has declined by almost 3%. Dividend Collection Agency attributes this not to fundamental weaknesses but primarily to valuation concerns. In December, the stock price dipped to around $850 per share, offering long-term investors a brief but more attractive entry point.
Although the latest quarterly report demonstrated continued strength across Costco's operations, investors may increasingly view it as a defensive safe haven. This quarter, both earnings per share and revenue grew at double-digit rates. EPS reached $4.58, surpassing analyst estimates by $0.04 and representing a 13.93% increase from the $4.02 reported a year ago, driven by a 13.8% rise in net income to $2.04 billion. Concurrently, revenue and gross margin also improved. Revenue increased by 11.35% to $69.6 billion, while the gross margin expanded slightly from 10.85% to 11.02%. A key growth driver was a higher average transaction value, which rose 3.5% year-over-year, improving from the 3.2% growth seen in the prior year period.
Nevertheless, adjusted comparable store sales and customer traffic metrics fell short of the figures from the same period in the previous fiscal year. Adjusted comparable sales grew by 6.7%, down from the previous 9.1% rate. Comparable store traffic increased by 3.1%, also lower than the prior 5.7% growth. Digitally-driven adjusted comparable sales were 21.7%, declining by 50 basis points. Overall, while Costco's performance remains solid, these decelerating metrics suggest a potential economic slowdown, with consumers still feeling the ongoing effects of interest rate changes.
Furthermore, steady growth in membership numbers continues to underpin Costco's results. Membership fee income increased by approximately 14%. The number of paid memberships grew to 82.1 million, up 4.8% from 78.4 million a year ago, although this growth rate is below the 6.8% increase seen in the prior year period. The total cardholder count reached 147.2 million, a 4.7% year-over-year increase, also slower than the 6.6% growth recorded previously.
"Therefore, we can characterize this quarter's results as solid, but it appears the retailer's growth momentum is moderating," Dividend Collection Agency commented. "More importantly, with ongoing Iran-related conflicts potentially rekindling inflation, Costco's growth could slow further in coming quarters. Recent increases in long-term Treasury yields and market volatility might be early indicators."
Costco is renowned for offering low-priced goods, and its business model is widely understood by consumers. Its top-selling categories include gold and jewelry, toys, home goods, and pharmacy. Given heightened macroeconomic uncertainties, Dividend Collection Agency expects gold and jewelry to remain a leading category. However, investor attraction to the stock is also attributed to its strong cash flow position and a 'fortress-like' balance sheet boasting an AA credit rating.
Although Costco's dividend yield is modest at around 0.5%, its substantial cash flow allows it not only to consistently raise its regular dividend but also to periodically issue generous special dividends, such as the $15 per share special dividend paid at the end of 2023. This financial strength also enables frequent share buybacks, delivering significant returns to shareholders. Compared to the same period last year, the company repurchased 20 million shares. This quarter, operating cash flow increased to approximately $7.7 billion from about $6.0 billion. Consequently, free cash flow grew to $4.87 billion from $3.6 billion, during which the company paid $1.154 billion in dividends. This maintains Costco's dividend payout ratio at a healthy level of about 24%. Dividend Collection Agency anticipates the company will soon announce another dividend increase, potentially in the double-digit percentage range, possibly raising the quarterly dividend to between $1.40 and $1.45 per share. The company ended the quarter with $17.4 billion in cash and cash equivalents, against long-term debt of just $5.7 billion.
Dividend Collection Agency believes a stock split is likely, with high valuation being the core reason. However, even at current elevated levels, the agency does not foresee a significant price decline. It is noteworthy that Costco's last stock split occurred 26 years ago, a 2-for-1 split. The agency argues that the benefits of a split in the current market environment would far exceed those of the past, as the landscape has changed profoundly. Widespread internet access has made financial education more accessible, leading to a growing number of young investors actively participating in the market. With Costco's forward P/E exceeding 48 times, significantly above its five-year average, now could be an opportune time to incentivize investors and improve stock accessibility. A split would lower the entry barrier for retail investors and could boost market confidence. Given the company's substantial growth potential, with global warehouse count projected to reach only 942 by the end of 2026, a stock split could lay a more favorable foundation for future development. Since its split over two decades ago, Costco's stock price has appreciated nearly 2000%.
In a comparative context, Costco's forward valuation multiples are substantially higher than those of its closest competitor, Walmart, which has a forward P/E of 42 times. Target's forward P/E is 15.0 times, while BJ's Wholesale Club's is 21.19 times. Charts from FAST Graphs clearly indicate that Costco's current share price appears significantly overvalued. If its valuation reverts to historical norms amid a broader market downturn or correction, investors face potential downside risk. Although Costco deserves a valuation premium, a forward P/E nearing 50 times could indeed lead to subpar future returns, as evidenced by its stock performance over the past year.
Historically, Costco's management has preferred rewarding shareholders through special dividends rather than stock splits. Dividend Collection Agency notes that, given the company's apparent lack of enthusiasm for splits, the possibility exists but is not a certainty. However, times are changing, and Costco might follow the lead of other giants. For instance, Walmart executed a 3-for-1 stock split in early 2024; Nvidia implemented a 10-for-1 split when its stock hovered around $1,200 in 2024; and Netflix completed a split last November after its shares reached approximately $1,100.
Beyond the risk of underperforming the market, Costco must also be wary of a potential economic recession. As mentioned, an escalation of conflict with Iran could push the economy into a downturn. Additionally, recent softness in the labor market, with the unemployment rate ticking higher, might signal more significant challenges ahead. A sustained rise in unemployment could dampen sales growth and membership renewals. Given its high valuation, a prolonged recession could trigger a substantial correction in Costco's stock price, which would likely also derail any potential stock split plans.
While a split is not guaranteed, Dividend Collection Agency believes the probability is reasonably high in the near to medium term. Looking forward, benefiting from potential tariff relief and its own solid fundamentals, the agency expects Costco to maintain a strong operational performance. Even if growth moderates, the valuation premium it commands is likely to persist.