Costco (COST) has long been a market favorite, but its current valuation has even the most bullish investors raising eyebrows as the company trades near all-time highs. Trading at earnings multiples that outpace some of the world’s biggest tech giants, it’s fair to ask: how can a warehouse selling pallets of toilet paper and rotisserie chickens possibly justify such a steep premium?
Timid growth projections, razor-thin margins, and a business model that hasn’t changed much in decades don’t exactly scream innovation. And yet, Costco continues to climb—largely, in my view, due to one key factor: risk perception. Because the company’s business model is so heavily anchored in predictable, recurring revenue from membership fees, its earnings stream is exceptionally stable.
That stability arguably justifies the stock’s lofty valuation—and forms the backbone of my bullish thesis, even if there’s little to no margin of safety. I agree with Costco’s critics—those who are skeptical about a warehouse full of assorted goods trading at a forward P/E of 58, a multiple literally higher than tech giant and AI trailblazer Nvidia. For a company like Costco, which has grown revenue at a ~10% CAGR over the past five years and operating income by 15%—yet is only expected by analysts to grow revenue at a 5% CAGR over the next five—it really doesn’t make much sense, at first glance, for the business to trade at such a steep premium.
But here’s what a lot of market participants miss when analyzing companies: valuations based on net earnings are heavily anchored to one key factor—risk. That’s where Costco stands out as a rare case: a recurring revenue model outside of the tech sector. Customers pay an annual membership fee—ranging from $60 to $120 in the U.S.—just to shop in its warehouses. Costco likely converts nearly all of that directly into operating profit (though the company doesn’t explicitly disclose this), which allows the business to be highly profitable even while selling goods at razor-thin margins.
In the most recent quarter, membership income rose 10% year-over-year, with a staggering 93% renewal rate in North America. That kind of brand loyalty and perceived value creates a business model with very little risk of earnings volatility. And because of that, Costco functions like a defensive stock, offering low risk and a high degree of predictability in returns. While only about 2% of Costco’s total revenue comes from membership fees, those fees account for more than half of the company’s total operating income. At this kind of scale, there’s simply no other retailer that can pull off a high-volume, low-margin model quite like the Issaquah, Washington-based warehouse giant.
That’s why, even during periods of weak consumer spending, Costco tends to remain highly profitable—not just because of its membership model, but because it consistently gains market share from competitors. By keeping margins razor-thin on discretionary items, and with shoppers naturally shifting toward essentials during times of financial stress, Costco puts pressure on rival retailers that simply can’t match its pricing without cutting into their own profitability.
Take Q3, for example: Costco’s comparable sales rose 8% year-over-year to $62 billion, while peers like Target (TGT) saw comparable sales shrink and were forced to revise earnings guidance downward. This highlights how Costco isn’t just weathering macroeconomic headwinds—it’s actually growing through them. In other words, macro risks seem to have a much lighter impact on a company like Costco.
While Costco’s relatively low-risk business model may warrant a valuation premium, it’s worth exploring what an appropriate stock price might look like under simplified assumptions. For this analysis, I’ll estimate an equity value for Costco using a basic perpetuity-based discounted cash flow (DCF) model. Let’s begin with the fact that, in fiscal year 2024, Costco generated approximately $4.8 billion in membership fee revenue. While this isn’t equivalent to free cash flow, it serves as a reasonable proxy for recurring operating cash flow due to its stable and high-margin nature.
With Costco’s current market capitalization at approximately $470 billion, we can reverse-engineer the valuation. If we assume a 6% discount rate—reflecting the company’s relatively low risk profile despite the 10-year Treasury yield sitting around 4.4%—and a perpetual growth rate of 5%, the implied equity value is approximately $480 billion, or about $1,083 per share. This closely aligns with Costco’s current share price.
These assumptions appear fairly reasonable and suggest that Costco’s valuation is justified under optimistic, yet not unrealistic, conditions. However, using a more conservative 7% discount rate, while keeping other assumptions constant, would cut the implied equity value significantly, roughly in half.
In summary, while Costco does not appear overvalued under favorable scenarios, the current valuation leaves little room for error. A meaningful margin of safety may only emerge if macroeconomic conditions shift, such as a recession prompting lower risk-free rates and, in turn, greater tolerance for elevated valuation multiples.
Out of the 25 analysts who have covered COST in the past three months, 17 rate the stock as a Buy, while the remaining eight call it a Hold. So, while the overall sentiment is moderately bullish, the average price target of $1,096.36 implies ~8.5% upside from the current share price over the next twelve months.
Given the strength and stability of Costco’s underlying business model, its premium valuation multiples appear justifiable. At present, there are no significant concerns that would challenge a constructive outlook on the stock. However, it’s important to note that the current valuation offers limited—if any—margin of safety.
As such, I maintain a cautious Buy rating on Costco. While near-term upside may be constrained, the company remains well-positioned to deliver steady, long-term compound growth.
