Readers are almost certainly familiar with both Costco (COST -1.05%) and Home Depot (HD -0.50%). These are two massive companies that have done a great job of compounding shareholder capital over the decades.
But which of these retail stocks is the better one to buy right now?
The case for Costco
Costco might look like a typical big-box retailer, but it stands out in one major way. It operates a thriving membership model. Not just anyone can shop at one of the company’s 876 warehouse clubs. Consumers must pay annual fees for their Costco cards, providing an extremely high-margin, predictable revenue stream for the business.
Historically, these memberships have displayed their pricing power. Annual dues were raised in 2011 and in 2017, and another price hike was just implemented this month. But over time, the customer base has only gotten bigger, from 40.9 million member cardholders a decade ago to 74.5 million today.
Costco benefits from tremendous customer loyalty. This makes sense because if someone pays for a membership, they’re encouraged to shop at the stores. There’s some customer lock-in here. The membership renewal rate was 93% in the U.S. and Canada last fiscal quarter.
However, Costco is also simply a favorite place to shop among consumers. Its large warehouses, bulk sizes, no frills, and treasure-hunt atmosphere are appealing to shoppers.
As the world’s third-largest retailer, Costco has cost advantages that support its competitive positioning. The business sells about 4,000 different stock-keeping units, much lower than Walmart. This gives Costco incredible bargaining power with its supplier partners, primarily because the company is buying such a high volume of merchandise. Those savings are continuously passed on to shoppers through low prices, which leads to more revenue in a positive feedback loop.
The case for Home Depot
With trailing-12-month sales of $152 billion, Home Depot is significantly larger than smaller rival Lowe’s. Part of Home Depot’s success stems from its strong positioning with professional customers, like contractors and electricians, who generate about half of Home Depot’s revenue, much more than Lowe’s.
Pros spend more money than DIY (do-it-yourself) customers. This has typically resulted in better profitability and return on invested capital than its top industry competitor.
Home Depot is feeling the pressure of the current macro environment, where consumers are holding off on big-ticket purchases and more complex renovation projects. That’s why same-store sales are expected to decline 3% to 4% in the current fiscal year.
Zoom out, though, and investors will notice that the industry backdrop is more accommodating. The median age of a home in the U.S. is about 40 years old, much higher than 35 years about a decade ago. Moreover, there is a sizable housing shortage. Both of these variables should drive durable demand for Home Depot.
And lastly, the bulls will point to Home Depot’s capital allocation policy. Because the company generates so much free cash flow, even after reinvesting in the business, there is a lot left over to reward shareholders.
Home Depot has paid a dividend in 150 straight quarters, shelling out $4.5 billion in the first six months of fiscal 2024. Management also isn’t shy when it comes to share repurchases. The outstanding share count has been reduced by 10% over the past five years.
The final word
Both of these top retailers certainly possess favorable attributes that should warrant a closer look from investors. However, there can be only one winner.
I believe Costco is a better business, as evidenced by its consistent track record of steady historical revenue and earnings growth, in addition to the factors laid out above. But I just can’t get over the price-to-earnings ratio of 55, more than double Home Depot’s 24. As a result, Home Depot, also a quality company, looks like the better stock to buy right now.
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 Walmart. The Motley Fool recommends Lowe’s Companies. The Motley Fool has a disclosure policy.
