Investors love Costco stock. But its smaller rival is a better buy right now.

By | March 18, 2024

Investors love warehouse chains Costco Wholesale (NASDAQ: COST), and for good reason. This well-managed company consistently keeps prices low for its members, despite the headwinds of inflation. And for its efforts, it is rewarded with member loyalty and high-margin recurring revenue from its membership dues.

This consistent source of profit allows Costco’s management to reward shareholders on a regular basis. One of the preferred methods is paying a growing dividend. It has paid and increased its dividend for 19 years in a row, and I expect this trend to continue for decades to come.

But if there’s one knock on Costco stock, it’s its valuation: The stock is expensive. Trailing earnings at 50 times right now, Costco shares are trading at a nearly 50% premium to the 10-year average for their valuation, as the chart below shows.

COST PE ratio chart

COST PE ratio chart

The late great Charlie Munger loved Costco stock, one of only three stocks in his personal portfolio. But even he regretted its appreciation.

What’s so great about BJ stock?

That’s why I want to bring it to your attention BJ’s Wholesale Club (NYSE: BJ) stock. It offers investors many of the exact same benefits as Costco stock, but is a much better bargain. Since the business model is membership-based, an investment thesis for BJ’s Wholesale Club revolves around the ability to recruit and retain members.

Since this is the core issue for BJ’s investment, shareholders should be encouraged. When BJ’s went public in early 2018, it had more than 5 million paid memberships. Now the country will have more than 7 million by the end of 2023.

BJ’s hasn’t just found new members; there are also old ones preserved. The company’s renewal rate in 2023 was 90%. For perspective, Costco’s renewal rate in the most recent quarter was only marginally better: 93%.

To retain members, both clubs must provide value to their customers. That’s why anyone would pay to shop there in the first place. One of the ways BJ’s appears to provide value to its members is through its private brands. In 2017, 19% of turnover came from its own line. But by 2023, the penetration rate was almost 26%.

In the long term, BJ’s management believes its private brands can reach 30% of sales. This should deliver value to members and, as a result, encourage a sustained high renewal rate.

BJ’s doesn’t just retain members at existing stores. It’s also opening new locations at a modest pace. By the end of 2023, it will have 244 club locations and the intention is to open 12 new locations this year. For what it’s worth, Costco has almost 900 locations, which suggests BJ’s can continue to grow for quite some time at its current pace.

According to the business model, membership fees are basically pure profit for BJ’s. In fiscal 2023, the company had full-year net income of $524 million. But membership fee revenues amounted to $421 million, which provided the bulk of these profits. Therefore, simply expanding its membership base, as it is doing now, will deliver the earnings growth shareholders need.

Should Investors Buy BJ’s Stock?

I won’t go so far as to say that BJ’s is a better business than Costco — Costco is undoubtedly among the very best. But BJ’s is a good company nonetheless. And its valuation is much more reasonable, which is why I think it’s the better buy.

COST PE ratio chartCOST PE ratio chart

COST PE ratio chart

Warren Buffett says that having a margin of safety is “the cornerstone of investing success.” In a nutshell, he means that it is important to buy stocks that are undervalued and avoid stocks that are overvalued.

Since Costco stock is trading at a 50% premium to its long-term average valuation, I think it’s easily overvalued today for those looking to take a position. Therefore, I would say there is no margin of safety in Costco stock.

BJ’s stock, on the other hand, is trading at a reasonable valuation – perhaps not grossly undervalued, but still reasonable. That’s why I believe this is the safer stock. And I believe the likelihood of market-based returns is much greater given the cheaper starting point.

BJ’s still needs to grow its membership base over the long term – this is the most important part of the investment thesis, and investors can’t fully buy into valuation metrics. But as I explained, paid memberships at BJ’s are going in the right direction, making it a good buy today.

Should you invest $1,000 in BJ’s Wholesale Club now?

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Jon Quast has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Costco Wholesale. The Motley Fool has a disclosure policy.

Investors love Costco stock. But its smaller rival is a better buy right now. was originally published by The Motley Fool

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