Costco Wholesale Corporation (ticker: COST ) has turned from a startup in an airplane hangar into one of the biggest players in the warehouse retailing industry. Investors who bought early on were able to capitalize on massive total returns, and Costco continues to grow at an attractive pace.

The company’s strong history is not a result of pure luck, but rather the result of great management, especially Costco’s CEO Craig Jelinek has been a factor for Costco’s very convincing long-term growth.

Company Overview          

Costco operates more than 760 warehouses (in the US and Canada) that gross more than $150 billion in sales a year. Costco is thus, by revenue generation, one of the biggest retailers in the US. The company, which was established in 1983, is currently valued at $87 billion.

Costco has reported its first quarter (fiscal 2019) earnings results on December 13. The company was able to generate revenues of $35.1 billion during Q1, an increase of 10.3% compared to the prior year’s quarter. Earnings-per-share totaled $1.73, an increase of 19% compared to the prior year’s quarter. Costco was also able to grow its comparable store sales at a massive pace of 7.5% during the quarter.

Growth Prospects      

Costco has a very strong growth track record, over the last decades its revenues and profits grew very consistently. Costco’s earnings growth is based on several factors: The company continues to open new warehouses, while at the same time the sales at its existing warehouses continue to rise. These rising comparable store sales are possible thanks to price increases (inflation) and a rising customer count. Rising comparable store sales allow Costco to generate increasing gross profits per location, while fixed costs (per warehouse) remain constant. This (theoretically) allows for rising margins, but Costco chooses to pass on fixed cost savings to consumers in many cases, which means that its margins do not grow every year. The low selling prices for its goods, in turn, lead to more traffic at Costco’s warehouses, which helps drive comparable store sales and revenues.

We believe that Costco should be able to grow its earnings-per-share at a high single digits pace going forward, with revenue growth being the most important factor for rising profits.

Valuation, Dividends, And Expected Returns

Costco’s shares are trading at $197 right now, as shares have already declined considerably from the 52-week high of $245 that was hit in September. Based on our forecast for earnings-per-share of $7.50 in fiscal 2019, Costco’s shares are valued at 26.3 times this year’s expected earnings right now.

This represents a relatively high valuation, both in absolute terms, as well as relative to how Costco’s shares were valued in the past. Despite the fact that Costco is a high-growth retailer with a strong track record, investors should still look at the price they have to pay for Costco’s shares. Over the last decade Costco was, on average, valued at a price to earnings multiple of 24, which means that Costco’s shares are about 10% overvalued right here.

Despite regular dividend increases Costco’s dividend yield is still relatively low, investors get a payout of just 1.2%. Costco is thus not suitable for investors that seek an income-producing investment.

Through a combination of earnings-per-share growth of 9% and a dividend yield of 1.2%, partially offset by a 2% valuation compression headwind, Costco could produce annual returns of 8% a year going forward. The total return outlook is thus positive, although Costco’s shares look a bit expensive.

Final Thoughts

Costco is a high-quality company with an excellent past and a strong outlook. If investors can purchase shares at or below $180 (our fair value estimate), Costco would be an excellent buy. Right here we believe it is favorable to hold shares, but not to add to a position.