Is Costco Stock Getting Too Expensive? 2 Things Investors Should Consider Before Buying.

The thought that investors should avoid Costco Wholesale (NASDAQ: COST) may seem counterintuitive to many. In 2023, an Axios Harris poll put Costco second among the nation's most admired brands. Its product selection and low prices have brought consistent sales growth for decades.

Despite these successes, have investors increasingly begun to question whether Costco stock remained a worthy investment. In 2020, Warren Buffett's Berkshire Hathaway closed out a long-held stake in Costco, a move Buffett later said was "probably a mistake."

His ambivalence about closing his position may leave investors wondering what to do. As you weigh decisions about Costco stock, consider these two points.

1. The state of the business

Costco is historically one of the most successful retail stocks on a long-term basis. A $1,000 investment in March 1982 would be worth over $1.5 million today, including dividends.

Moreover, it has developed a loyal following among members of its wholesale clubs. The company sells high-quality goods at little more than cost plus overhead. This approach has helped inspire membership renewal rates exceeding 90% globally, and the recent increase in membership fees did not seem to faze its customers.

It opened 30 new warehouses in fiscal 2024 (ended Sept. 1), bringing the total to 890. Of those new locations, 23 are in the U.S., with the remainder in Costco's foreign markets.

It's hard to overstate its international success. Other successful retailers including Walmart and Home Depot made costly mistakes in overseas markets due to cultural differences. But Costco's low-priced merchandise is as well received in France or China as in the U.S., dramatically expanding its growth potential.

2. The financial metrics

Unfortunately, these successes will not draw growth investors. In fiscal 2024, revenue of $254 billion rose by 5% from year-ago levels. Also, net income increased 17% during that period to nearly $7.4 billion as the rise in expenses slightly lagged the company's revenue growth.

That growth rate could leave investors wary of its valuation. At a price-to-earnings ratio (P/E) of 54, the stock is more expensive than at any time since the bull market in the late 1990s. Also, it has become so highly valued that its P/E has overtaken that of Amazon, another historically high-priced stock that now sells at 45 times earnings.

The earnings multiple is a testament to the demand for high-quality stocks and the fact that Costco's popularity and solid management are known quantities to investors.

Unfortunately for would-be investors, rapid growth prospects are not the reason for its valuation. At a forward P/E of 50, the stock price is likely ahead of the company's growth and may indicate it faces more near-term potential for downside than upside.

Worse, the prospects are dim if you want to hold out for a lower share price. The P/E has not fallen below 30 since 2019, and its earnings multiple has not reached 15 since the depths of the 2008-09 financial crisis!

COST PE ratio data by YCharts.

Even if such dire conditions return, it is likely that other stocks on investors' watch lists may hold higher potential, further frustrating prospective buyers. Hence, those who decide they have to own Costco must resign themselves to paying a premium. And that increases the possibility of underperforming the S&P 500, which makes the stock risky.

Should you buy the stock?

When considering the state of Costco's stock, you should probably stay on the sidelines.

This is not a conclusion made lightly. The company is one of the best retailers. It has succeeded in offering quality products that customers want, at low prices. That has helped build member loyalty reflected in the more than 90% renewal rate, even as it hiked membership fees with little fanfare.

Unfortunately, investors have priced in the strength and growth potential of Costco's business, perhaps too much. Although it will likely continue to grow, its 54 P/E ratio is near an all-time high and leaves the stock with more potential downside than upside.

Without a massive pullback, the prospect for market-beating returns is too low to make buying Costco worth it at this time.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Will Healy has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Amazon, Berkshire Hathaway, Costco Wholesale, Home Depot, and Walmart. The Motley Fool has a disclosure policy.