Costco operates a membership-based model with a durable competitive moat in retail, anchored by industry-leading renewal rates and a value proposition that strengthens with scale. The recurring membership-fee stream is high-margin, predictable, and compounds alongside member growth and periodic fee increases. Backed by an experienced and capable management team, we believe this combination will translate into continued high dividend growth.

Costco Wholesale Corp. (COST) was the second-largest contributor for the quarter, gaining 16% as the company benefited from two distinct tailwinds. In the first two months of the quarter, Costco’s consistent, membership-driven business model provided a defensive haven as investors rotated away from high-multiple technology stocks amid capex cycle concerns. Then in March, as the Iran conflict drove consumers toward value-seeking behavior, Costco’s warehouse model and unmatched value proposition attracted incremental traffic. Comparable store sales growth remained in the mid-to-high single digits year-over-year, membership renewal rates remained above 90%, and e-commerce penetration continued to accelerate. The company’s ability to compound through a variety of macro environments reinforced its status as one of the highest-quality retailers globally.

Costco Wholesale: COST was the third-largest contributor for the quarter, gaining 16% as the company benefited from two distinct tailwinds. In the first two months of the quarter, Costco’s consistent, membership-driven business model provided a defensive haven as investors rotated away from high-multiple technology stocks amid capex cycle concerns. Then in March, as the Iran conflict drove consumers toward value-seeking behavior, Costco’s warehouse model and unmatched value proposition attracted incremental traffic. Comparable store sales growth remained in the mid-to-high single digits year-over-year, membership renewal rates remained above 90%, and e-commerce penetration continued to accelerate. The company’s ability to compound through a variety of macro environments reinforced its status as one of the highest-quality retailers globally.

Costco exemplifies a business model that is adaptable and relevant in tomorrow’s economy, showcasing durable pricing power protected by a growing competitive advantage. The manager highlights that successful companies like Costco have periods where management prioritizes growth over maximizing after-tax earnings, which can make them appear expensive based on traditional metrics but very cheap in terms of earnings power. This long-term focus on reinvestment positions Costco well for future value creation, especially in a slowing economy where insulated growth runways become increasingly valuable.

Costco's competitive edge is derived from the accumulation of hundreds of difficult to replicate capabilities, such as charging membership fees, paying employees more, capping product margins, and limiting SKU selection. Individually, these choices may not seem like decisive advantages, but collectively they create a system that is nearly impossible to reverse-engineer, making Costco's business model hidden and valuable.

Costco is mentioned as one of the companies that has seen market cap increases well in advance of fundamentals. The letter discusses the overall market being extremely rich, with Costco being categorized among the most expensive stocks relative to historical valuations. However, there is no explicit bullish or bearish argument made regarding Costco's future performance.

Costco has underperformed the SP500 this year and is part of a defensive group, which was shunned by investors during the quarter. Falling only 4.3% during the quarter, Costco was punished mainly for its role as a 'Low Volatility' stock. Low volatility stocks returned 0.25% in Q3 versus a gain of 13.2% for momentum driven companies.

Costco continues to deliver market share gains due to its focus on being the low-price leader and its differentiated business model with high turnover and limited SKUs. The company reported a strong second fiscal quarter with U.S. comparable sales up 8.6% excluding gas deflation. E-commerce sales were up 22.2% after adjusting for foreign exchange. Operating income increased by 12.3%. Paid household members increased by 6.8% and renewal rates remain strong in the U.S. and Canada at 93%. Costco added one new warehouse in the first quarter and plans for 27 more openings throughout the rest of the fiscal year.

Costco is currently trading at 55x+ earnings, and with expected growth of only 11%, I am highly skeptical of this number as they have only grown in the single digits since 2022. The company is vulnerable to recessionary scenarios and is not as defensive as individuals believe. Their consumer base has shifted to include more low-income consumers, making them more exposed to the cyclical nature of retail. With Canada boycotting American goods and tariffs impacting their supply chain, it is unlikely Costco will maintain its lofty valuation in the coming months.