Costco (COST 0.85%) and Home Depot (HD -0.78%) carry market caps of $389 billion and $406 billion, respectively. Consequently, I’m sure many investors are also customers of these two massive businesses. Both retail stocks have rewarded shareholders over the past few decades, but one is obviously the better company to buy right now.
Costco is the gold standard in the industry
With fiscal 2024 net sales of $250 billion, Costco is the third-biggest retailer in the world. It’s known for selling quality merchandise in a broad range of categories at some of the lowest prices around, which is why it has come to dominate the retail sector.
Costco’s size helps it benefit from powerful scale advantages, which is its key competitive strength. The business carries far fewer stock-keeping units than its rivals. Therefore, it has tremendous negotiating leverage when purchasing goods from suppliers. This results in lower per-unit costs, savings that are always passed on to shoppers.
The trait that makes Costco stand out is its membership model. Consumers must pay an annual fee to have the right to shop at one of the company’s warehouses. In the latest fiscal quarter, membership revenue increased 7.4% to $1.5 billion on a normalized basis year over year. This provides the business with a high margin and predictable revenue stream while also driving customer loyalty. That combination is hard to beat.
Costco has a history of steady revenue and profit growth. The consistency of the bottom line has actually helped management pay out one-time special dividends. In January, the business paid out $15 per share. Before that, a special $10 dividend was paid in December 2020. This is in addition to the regular quarterly payout. A favorable capital allocation policy like this helps to boost returns.
Home Depot’s temporary setback
Home Depot registered double-digit revenue growth in fiscal 2020 and fiscal 2021, as demand was strong during the worst days of the pandemic. But things have cooled down recently. Higher interest rates and inflationary pressures have discouraged shoppers from spending on costly renovation projects.
As a result, the top line has taken a hit. Same-store sales decreased 3.2% in fiscal 2023 and are expected to drop between 3% and 4% in the current fiscal year.
But better days are likely on the horizon. For starters, Home Depot benefits from some favorable industry tailwinds. The median age of a home in the U.S. steadily rises with each passing year — it’s now at 40 years old. The fact that there’s a sizable housing shortage in this country also supports the demand for home renovation activity.
Additionally, according to data from Redfin, the median price of a home today is $433,000. That’s up about 45% just in the last five years. This rising equity that homeowners have could be tapped to fund renovation projects. The prospects of lower interest rates going forward could also spur a new trend of sales growth for the company.
As of this writing, shares of Home Depot trade at a price-to-earnings (P/E) ratio of 27.6. That’s not a bargain by any stretch, but it’s much more reasonable than Costco’s 53.1.
Costco’s impressive scale advantage, coupled with its recurring revenue stream and steady financial results, make it the higher-quality business of these two. But its shares go for a nosebleed P/E multiple right now. This implies lofty expectations for the warehouse club operator, with the high valuation creating a major headwind to achieving strong investment returns.
If we look at things over the next five years, I’d argue that Home Depot is likely to produce a better gain for your portfolio than Costco.
Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale, Home Depot, and Redfin. The Motley Fool recommends the following options: short November 2024 $13 calls on Redfin. The Motley Fool has a disclosure policy.
