Wal-Mart ( WMT) may be the world's largest retailer, but in terms of the stock market, Costco ( COST) has emerged as lord of the discounters.

Shares of Costco have climbed 16.2% since the beginning of 2005. During that span, rival warehouse retailer B.J.'s Wholesale Club ( BJ) added 7%, while Target ( TGT) rose 6% and Wal-Mart dropped 12%.

Strong same-store sales gains, growth opportunities, labor harmony and an impeccable reputation for execution have all lent momentum to Costco. Amid speculation that the Seattle-based warehouse chain will soon raise its membership fees, shares hit a five-year intraday high Tuesday of $54.70. Now, some observers are wondering if the company's valuation has gotten too big for its britches.

"I'm not disputing that Costco is a great company," says HSBC analyst Mark Husson, who is one of two analysts out of 24 on Wall Street who holds a negative rating on the stock (his firm has an investment banking relationship with Costco). "I just think the stock has gotten too expensive considering the risks that it's facing."

At over $54, shares of Costco are trading at more than 20 times its earnings estimates through 2007. That's a hefty premium compared with Wal-Mart, which trades at less than 14 times estimates. B.J.'s trades at just over 14 times estimates, and Target trades at about 15 times projections.

As the largest U.S. warehouse club chain, Costco competes most directly with Wal-Mart's Sam's Club chain, which posted a 5.1% same-store sales rise over its previous four quarters, compared with Costco's 7.5% gain. B.J.'s logged a 4.1% increase in that span. Same-store sales, or comps, is a key performance gauge in retailing, measuring sales at stores open for at least a year.

"Costco's stock is starting to get pricey, but I think it definitely deserves a premium over Wal-Mart since it's one of the few retailers out there that competes head-on with them and, quite frankly, beats the pants off them," says Morningstar analyst Anthony Chukumba. "They're incredible merchants. Their customer service is pretty much the best out there in all of retail. They treat their employees better. They pay them more. Their benefits are better, and the company still has room to grow both at home and abroad."

Chukumba says the average hourly wage at Costco is $17, compared with $10 at Wal-Mart. Also, Costco workers pay only 10% of their health premiums, on average, compared with the 33% paid by Wal-Mart's workers and the retail average of 23%. While this generosity has sparked criticism from Wall Street, Costco claims its compensation policies reduce employee turnover to less than 17%, excluding seasonal factors.

Higher compensation also lowers training costs, and it helps the company avoid the storm of public criticism that has been directed at Wal-Mart from unions, politicians and community activists.

"For our business, it has been important that we hired good people," says James Sinegal, Costco's co-founder, chief executive and president. "We've been a growth company since our inception. We want to continue to grow, and we promote almost entirely from within our company. Our view has been that if you hire good people and provide good jobs and good careers at good wages, then good things will happen to your business."

Thanks to its merchandising prowess, Costco has also been able to attract higher-income customers. It's the nation's largest seller of wine and it's also a prolific seller of items like designer clothing. Recently, the company has been expanding its online business, as well as its offerings in fresh foods and home furnishings. Sinegal says the company has plans to expand in other markets, but he declined to divulge specifics of those plans.

Meanwhile, Costco has consistently generated returns on its invested capital that are well higher than its average cost of capital. Chukumba estimates that its cost of capital is about 9.3%, while its returns have averaged roughly 14.2%. He expects that metric to increase to 15% this year.

On the growth front, Costco recently told investors it expects to add about 30 new stores this year. That marks an increase from the 16 warehouse clubs opened last year and the 20 opened in 2004. It currently operates 471 warehouses.

"The way we view things at the moment, we think it's possible that we could double the size of our company in the next 10 years, but that's obviously easier to say than to do," Sinegal says. "That plan could be altered by a lot of different things. We can't account for floods, wars, depressions and everything else that could happen."

Traders view recent $5 increases in membership costs at both Sam's Club and B.J.'s as a positive catalyst for Costco, which has maintained its fees at $45 for a new basic or business-level membership. If it was winning market share before its competitors raised prices, that trend could pick up more steam now.

Alternatively, Todd Slater, an analyst with Lazard Capital Markets, said in a recent research note that he expects an increase in membership fees from Costco, considering recent changes in California's tax law.

"Perhaps Costco is attempting to both make B.J.'s and Sam's sweat and to pick off defecting members alienated by its competitors' recent fee increases," Slater said (his firm makes a market in shares of Costco). "However, we believe a fee hike is inevitable in the very near future, particularly given an increase in the California sales tax exemption to $50 from $45 for membership fees."

Sinegal declined to comment on Costco's plans for its membership fees.

In the end, some investors could become the victims of Costco's success, as all the good news may be boosting its stock price too high. HSBC's Husson notes that its three-year annualized growth in earnings per share is 10.1%, compared with Wal-Mart's 12.5% and Target's 20.1%. He also thinks Costco's middle-class customer base, and its store concentration on the West Coast, make it particularly sensitive to the slowing real estate market.

"The housing market in California looks particularly frothy, and Costco's customers are just the sort of consumers whose spending has been powered by extracting cash out of their homes," Husson says. "A housing slowdown could hurt their ability to keep spending and that could hurt Costco's sales."

On the contrary, Sinegal says Costco's wealthier customers on the discount scale will be the last demographic to be hurt by a housing slowdown, but he does acknowledge concerns about the long-term health of the economy.

"I get very nervous about the housing market," Sinegal says. "I've seen some of the numbers out there that imply there's a significant amount of adjustable, interest-only mortgages out there. If interest rates were to increase, the cost of those monthly payments could escalate about 50% to 70%, depending on how much interest rates go up. That's scary, so we're cautious in that regard."

Sinegal declined to comment on his company's stock price. Husson says the economic concerns aren't priced in to the market's current valuation.

"When things are going well like this, people tend to forget about valuation and they just keep bidding the stock higher," Husson says. "As soon as something goes wrong, valuation suddenly comes into focus, and that often results in a selloff."

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