In the past decade, shares of Costco (COST -0.99%) have generated a monster total return of 731%. This means that an investor who put $10,000 into the stock in late February 2015 would be sitting on a balance of over $83,000 today. The huge gain far exceeds the performance of the overall S&P 500.

This top retail stock trades near record territory. And the company's market cap is steadily approaching the $500 billion mark. It's no wonder given Costco's impressive performance.

Should investors buy, sell, or hold shares?

Costco's bullish case

It's not difficult to find reasons to appreciate this company. I think there are three top factors that support the bullish case for Costco.

For starters, the company benefits from a major cost advantage. Costco raked in $250 billion in net sales in its fiscal 2024 (which ended Sept. 1). This means it has tremendous negotiating leverage over its suppliers when it's buying merchandise for its hundreds of warehouses.

And this results in everyday low prices for consumers. Costco maintains a low gross margin of 12% to 13%. The purpose is to drive greater sales volume, which reinforces its existing cost advantage.

Another bull case comes from customer loyalty. Of course, selling high-quality goods at low prices might be enough to keep customers happy and coming back for more; this is what all retailers want. And Costco does well in this regard, as exemplified by its ability to grow same-store sales at a solid clip year in and year out. Costco experiences durable demand, which reduces risk for investors worried about correctly forecasting the direction of the economic cycle.

But what separates Costco from an operational perspective is its membership model, which requires customers to pay annual fees for the right to shop at warehouse locations. These fees have strong renewal rates, they produce pricing power, and they provide a recurring, high-margin revenue stream.

All these factors help Costco consistently increase its net income, which is another reason to be bullish on the business. In the past decade, net income rose by 258%. This was faster than the 126% gain in revenue, indicating Costco's scalability.

Generating positive earnings and free cash flow on a regular basis is fantastic to see -- and Costco's management team isn't shy about returning excess capital to shareholders. Yes, the company pays a regular dividend that yields just 0.45%. But every once in a while, investors are rewarded with a sizable one-time dividend, the last one being $15 per share paid in January 2024.

The only reason to steer clear

Anyone who spends time understanding Costco's business and its financial success will certainly come away impressed. This is truly a great company, and I don't believe anyone will argue with that statement.

Moreover, this perspective might make you question why you don't own this stock in your own portfolio. After all, the company's track record speaks for itself when it comes to compounding shareholder capital.

But it's also important for investors to gauge the market's sentiment. Considering the valuation is a key part of the puzzle that shouldn't be ignored, and this is where Costco leaves much to be desired.

The stock trades at a price-to-earnings (P/E) ratio of around 61. Throughout its entire history as a public company, which goes all the way back to 1985, Costco shares have only once been more expensive (earlier in February). It's safe to say that the investment community is head over heels with this company.

The steep valuation leaves prospective shareholders with zero margin of safety. Despite what history suggests, I have low confidence that Costco can outperform the S&P 500 over the next five or 10 years. I think it's best to wait for a lower valuation before buying.