What Could Possibly Go Wrong with Costco Stock?

By Markets Fool.com

Costco is dominating in 2015, with its shares up more than 11% so far this year. That compares to a modest 1.28% spike in the S&P 500 Index over the same period and a 5% decline in shares of bix-box competitor Wal-Mart. Costco shares are now trading around $149 apiece or near the high end of the stock's 52-week range.

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Costco stock looks expensive as it's currently boasting one of the highest price-to-earnings growth rates or PEG values in the industry today. On top of this, Costco runs the risk of over extending itself in the U.S. market where the warehouse chain has tens of millions of existing members. In this context, let's take a closer look at Costco's prospects in the quarters ahead.

Going for growth
Costco is doing many things right these days as shown by its ability to generate annual net sales north of $100 billion. In fact, based on revenue, Costco is now the third-largest U.S. retailer. With strong cash flow from its membership- based business model, it's hard to imagine anything going wrong with Costco stock today. However, the retailer isn't without risks.

For example, the company runs the risk of cannibalizing existing sales by aggressively opening new stores. Costco currently operates 474 warehouses in the United States, and the company plans to open as many as 20 new locations in the U.S. this year. The concern is that these newer locations could pull members away from Costco's existing warehouses thereby hurting same-store sales and in-store traffic at its current store base. That said Costco still has a smaller footprint than Wal-Mart's rival wholesale chain Sam's Club, which counts 647 locations in the United States today.

Source: The Motley Fool.

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Weak membership growth is another potential risk for Costco. The wholesale retailer relies on membership fees for a whopping 75% of its operating profit. This means Costco's profitability would take a serious hit if customers stopped renewing their memberships, opting instead for more convenient options such as online delivery services like those now offered by e-tail titan Amazon .

Costco faces increased competition from one of the world's largest online retailers as Amazon expands its Prime Pantry service through out the U.S. Amazon launched the service last year, which lets its Prime members order household items of up to 45-pounds (per Prime Pantry box) for a delivery charge of just $5.99. Of course, Prime Pantry customers will also need to pay for the cost of the products purchased.

But, hey, just six bucks for the convenience of having these items delivered to your front door is a sweet deal. Amazon is estimated to have around 40 million Prime members today. Therefore, if the e-tailer continues to invest in its Prime Pantry offering it could be a competitive threat to Costco down the road. While Costco does have an e-commerce site, sales from its online segment only made up 3% of the company's overall net sales last year.

While these things aren't deal breakers for owning Costco stock today, they are certainly worthy of investors' attention. Nonetheless, Costco's business model generates loads of cash flow for the company and should continue to do so for many years to come. Still, investors may want to wait on the sidelines for now until the stock comes down from its recent highs.

The article What Could Possibly Go Wrong with Costco Stock? originally appeared on Fool.com.

Tamara Rutter owns shares of Amazon.com. The Motley Fool recommends Amazon.com and Costco Wholesale. The Motley Fool owns shares of Amazon.com and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.