Costco Stock: Why Low Margins Support Its Model

Low profit margins are usually something investors approach with caution. A company that retains only a small percentage of its revenue has less room to absorb unexpected costs, competitive pressure or operational mistakes. Higher margins, all else equal, generally seem preferable.

But not every business is designed to maximize the profit earned on each transaction. Some deliberately accept lower merchandise margins because doing so strengthens customer loyalty, increases purchasing volume and supports a different source of income.

Costco Wholesale (COST) is one of the clearest examples. Its recently filed fiscal 2026 annual report shows a company generating nearly $300 billion in annual merchandise sales while maintaining a merchandise gross margin of just 11.09%. At the same time, membership fee revenue reached $5.9 billion and renewal rates remained exceptionally high.

The interesting investment question is not simply whether Costco could charge customers more. It is whether deliberately keeping prices low helps create more economic value over time than maximizing merchandise margins would.

Costco's merchandise margins are deliberately low

Costco reported fiscal 2026 net merchandise sales of $297.2 billion, an increase of approximately 10% from the previous year. Merchandise costs amounted to $264.3 billion, leaving merchandise gross profit of approximately $33.0 billion.

That translates into a merchandise gross margin of 11.09%, compared with 11.12% in fiscal 2025.

For many retailers, such a narrow gross margin might raise questions about the strength of the business. However, Costco's fiscal 2026 Form 10-K explains that operating with significantly lower gross margins than many competitors is an intentional part of its business model.

Costco seeks to offer consistently attractive prices on a relatively limited selection of products. High sales volumes, rapid inventory turnover, efficient distribution and disciplined operating costs are intended to make this strategy economically sustainable.

In other words, the company is not necessarily failing to capture higher merchandise margins. It is deliberately choosing a business model that prioritizes volume, efficiency and customer value.

The membership model changes the economics

To understand why this strategy can work, investors need to look beyond the merchandise itself.

Costco generated $5.91 billion in membership fee revenue during fiscal 2026, an increase of approximately 11% from $5.32 billion in fiscal 2025. Membership revenue represented less than 2% of total reported revenue, but it is a meaningful component of the broader operating model.

The accounting distinction matters. Membership fees are revenue, not pure profit, and the company incurs costs to attract, retain and serve members. Investors should therefore avoid treating the entire $5.91 billion as incremental earnings. Nevertheless, membership income provides an additional source of revenue beyond the gross profit earned from selling merchandise.

At the end of fiscal 2026, Costco reported 84.1 million paid memberships, compared with 81.0 million a year earlier. The renewal rate stood at 92.3% in the United States and Canada and 89.8% worldwide.

Those figures are important because the membership model depends on maintaining a sufficiently attractive customer proposition. Consumers need to believe that the savings, product selection and shopping experience justify paying for access every year.

A customer who repeatedly finds good value has a reason to renew. A large and loyal membership base, in turn, supports substantial purchasing volume and helps Costco negotiate and operate efficiently.

This relationship explains why maximizing the margin on every product may not be in shareholders' long-term interests.

Lower prices can support a competitive advantage

Imagine a retailer that increases merchandise prices to improve its gross margin. In the short term, profitability per unit could improve, provided customer demand remains reasonably stable.

But higher prices could also weaken the reason customers shop there. If consumers begin questioning the value of their memberships, renewal rates and shopping frequency may eventually suffer. The business might then lose some of the purchasing and operating efficiencies that made its original model attractive.

Costco's approach works in the opposite direction. By prioritizing competitive prices, it attempts to maintain customer loyalty and substantial shopping volumes. Those volumes support purchasing efficiency, distribution economics and inventory turnover.

This is where the concept of economies of scale and structural cost advantages becomes relevant. Large purchasing volumes and efficient operations can create cost advantages that are difficult for smaller competitors to reproduce.

However, size alone does not establish a durable economic moat. Investors still need evidence that a company's advantages translate into persistent economic benefits and remain defensible against competition.

Costco's operating characteristics make the competitive-advantage question particularly interesting. Its annual filing notes that the company often sells inventory before suppliers require payment, while also benefiting from high-volume purchasing and efficient distribution. These operating characteristics can reduce the capital tied up in merchandise relative to a less efficient business.

The potential advantage is therefore not simply that Costco sells inexpensive products. It is that its operating structure may allow it to sell products at attractive prices while still generating satisfactory financial returns.

Membership growth is more informative than fee revenue alone

One potential mistake is to interpret rising membership revenue as evidence that the membership franchise is necessarily becoming stronger.

Membership income can increase for several reasons. A company can attract additional members, increase annual fees, encourage customers to upgrade to more expensive membership tiers or benefit from a combination of those developments.

Costco's fiscal 2026 results contain all three elements.

The company's September 2024 membership fee increase continued contributing to reported growth. According to the annual filing, that earlier price adjustment accounted for approximately 30% of membership fee revenue growth during fiscal 2026.

Paid membership numbers also increased, while Executive memberships expanded from 38.7 million to 42.3 million.

These are different sources of growth, and distinguishing between them matters. More memberships suggest the company is expanding its customer relationship base. Higher fees increase revenue from existing memberships. Upgrades suggest customers are finding enough value in the broader offering to select a higher membership tier.

All can be positive, but they do not provide identical evidence about the underlying business.

Renewal rates add another perspective. Sustained retention suggests members continue finding the proposition worthwhile, although renewal data alone cannot establish how much pricing power the company possesses or how vulnerable it might be to future competition.

What the latest sales figures add

Costco's more recent trading figures provide additional context.

On October 7, the company reported September retail-month sales of $30.02 billion, up 13.0% year over year. Comparable sales increased 11.4% on a reported basis and 7.6% after excluding the effects of gasoline prices and foreign exchange.

Digitally enabled sales increased approximately 19% after adjusting for foreign exchange.

The September figures are encouraging, but they require the usual care. Monthly comparable-sales numbers can be affected by calendar differences, purchasing patterns, merchandise mix and other temporary factors. They are useful observations rather than definitive proof of improving long-term economics.

For a membership retailer, investors should ultimately connect sales development to the durability of the customer relationship. Growing sales are valuable, but the more interesting question is whether the company can continue attracting and retaining members while operating efficiently and maintaining its value proposition.

What MOATEY currently sees in Costco

The latest MOATEY assessment provides a useful distinction between business fundamentals and investment attractiveness.

As of October 9, Costco is classified as a Stalwart and receives a Risky rating with an overall score of 43.1 out of 95. Fundamentals contribute 43.1 out of 65 available points, while Valuation currently contributes zero out of 30.

Within Fundamentals, Financial Health receives 15 out of 15 points and Growth receives 10.3 out of 15. The Moat assessment stands at 11 out of 20.

That Moat assessment should not be interpreted as proof that every proposed source of competitive advantage is established. MOATEY currently identifies a positive trend in its Earnings Power Value versus Net Reproduction Value analysis, but the broader evidence is mixed rather than uniformly decisive.

The framework's current Valuation assessment is also important. A business can possess attractive operating characteristics while its shares still offer an unattractive risk/reward relationship at the prevailing market price.

Following Costco's September results, MOATEY's rating changed from Poor to Risky as several fundamental growth measures improved. The current rating nevertheless remains cautious because Valuation contributes no points.

These are MOATEY framework observations, not predictions of future share-price performance. Readers interested in examining the systematic methodology and supporting research can review the MOATEY factsheet and documentation.

What should long-term investors monitor?

The first important measure is membership retention. Sustained high renewal rates would support the argument that customers continue receiving sufficient value from Costco's offering. Growth in paid memberships and Executive membership penetration can provide additional evidence.

The second is merchandise economics. Costco does not need unusually high merchandise margins for its strategy to work, but it still needs to generate enough gross profit to cover operating expenses and reinvest in the business. Investors should therefore monitor both gross-margin development and the costs required to support sales.

Inventory turnover and cash generation are equally relevant. Efficient inventory management can improve the economics of a low-margin retailer, particularly when merchandise moves quickly and supplier payment terms remain favorable.

Expansion introduces another question. Costco ended fiscal 2026 with 939 warehouses worldwide and intends to continue opening locations. New warehouses can increase purchasing scale and membership reach, but they also require capital investment and may take time to achieve mature operating economics.

Finally, investors should keep the business assessment separate from the valuation of its shares. High customer loyalty and an efficient operating model may justify investor interest, but they do not make every purchase price sensible.

Thin margins can be a strategic choice

Costco demonstrates why investors should be careful when comparing profit margins across businesses with fundamentally different operating models.

An 11% merchandise gross margin might indicate competitive weakness at one retailer. At another, it can reflect a deliberate decision to prioritize customer value, inventory turnover and purchasing scale, supported by a separate membership revenue stream.

Costco's latest annual filing provides evidence of a business that continues attracting members, retaining existing customers and generating substantial revenue despite intentionally narrow merchandise margins.

That does not automatically establish an unassailable competitive advantage, nor does it answer whether the stock is attractively valued.

It does illustrate a broader investing principle: the highest margin is not always the best margin. What matters is how a company's pricing, costs, customer relationships and capital requirements work together to produce durable economic value.