Whatever You Do, Don't Ditch Costco

Even though Costco (Nasdaq: COST  ) reported admirable quarterly results this week, some stockholders are getting squeamish. Long-term investors should resist that fear and hold on to this great stock.

Costco's third-quarter earnings increased 5.9%, to $324 million, or $0.73 per share. Net sales surged 16%, to $20.19 billion. Same-store sales increased 12%; strip out gasoline price inflation and foreign currency effects, and total comps still increased an impressive 7%. Even in the U.S. market, Costco performed well, with comps increasing 10% (or 6% without gas and foreign currency).

Meanwhile, Costco's membership fee revenue also increased, showing that even in this tough economic climate, plenty of consumers remain willing to pay up for Costco's great deals.

Costco's profit did miss analysts' estimates, providing one explanation for investors' current negativity. Costco must also contend with the same inflationary price pressures currently plaguing many consumer-facing companies. The company's efforts to keep prices down for its customers are eating into its profit.

However, compared to the outright struggles that many consumer-facing companies endure these days, Costco looks pretty darn good. Wal-Mart (NYSE: WMT  ) continues to flounder here in the U.S., and a ton of other retailers and consumer-goods companies have reported disappointing quarters and outlooks. Fellow discounter Big Lots (NYSE: BIG  ) joined the chilly chorus of companies reporting profit and sales drops. On the other hand, BJ's Wholesale (NYSE: BJ  ) bucked the trend and reported a better-than-expected quarter.

Many companies are passing on price increases to consumers, as risky as that may be. Faced with the soaring cost of their raw materials, Starbucks (Nasdaq: SBUX  ) and J.M. Smucker (NYSE: SJM  ) announced plans to raise coffee prices recently.

Costco's wise to put off passing price increases to its shoppers for as long as it can. Losing its reputation as a purveyor of good deals would hurt its long-term success, which is much more important than assuaging investors and Wall Street analysts right now.

Furthermore, sacrificing margins to boost sales volume has worked well for other companies in the past. Amazon.com (Nasdaq: AMZN  ) has frequently employed this strategy, helping the e-commerce giant retain its competitive edge through thick and thin.

Although Costco's multiples tend to be pricier than those of its peers, paying up for a gold-standard stock is worth it. What Costco sacrifices now will help it succeed for the long haul; long-term investors know that, and may even hope for a few bearish price drops to get shares just a tad cheaper. Regardless, whatever you do, don't ditch Costco.

The Motley Fool owns shares of Wal-Mart, Costco, and Starbucks. Motley Fool newsletter services have recommended buying shares of Amazon.com, Costco, Wal-Mart, and Starbucks. Motley Fool newsletter services have recommended creating a diagonal call position in Wal-Mart. Try any of our Foolish newsletter services free for 30 days.

Alyce Lomax owns shares of Starbucks. For more on this and other topics, check back at Fool.com, or follow her on Twitter: @AlyceLomax. 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.


Read/Post Comments (6) | Recommend This Article (16)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 27, 2011, at 2:52 PM, catoismymotor wrote:

    If I were into investing in retail Costco would be at the top of my list followed by Whole Foods. Even to a investor that is just a casual observer of the stock it is plain to see the quality in the brand.

  • Report this Comment On May 27, 2011, at 6:43 PM, Joulesh wrote:

    Costco is over-sold right now. They plan on adding about 25 stores next year. Wal-Mart plans on adding about 60 stores. Wal-Mart wisely issued a bond at a great rate and is using that money quite well. I expect them to generate considerably more than the 5.5% interest rate on their bond debt. Wal-Mart's profit margin is 3.87% vs Costco's 1.7%. Wal-Mart also has a higher ROE, ROA, and beats Costco in owner earnings as well. Everyone is ecstatic over Costco's 6% quarterly profit growth. Wal-Mart's was 4.4%. Sam's Club grew 4.9%. So my money is on Wal-Mart for many reasons. The stock is attractive given the current performance of the company. There is a high likelihood for U.S. revenues to greatly increase as the economy recovers and society becomes more value-conscious and thrifty. Their rapid expansion into rapidly developing international areas fueled by their bond will produce huge gains and Sam's club will continue to grow membership. They also have a few ideas up their sleeve in the arena of e-commerce. Wal-Mart has a long record of growing shareholder's investments quite well. If I owned costco, I would hold it and buy when the economy recovers and it takes off. If I didn't own costco, I would buy Wal-Mart. It's a safer bet since it's more fairly valued and has the greatest potential for growth. Also, you have to love those dividend increases.

  • Report this Comment On May 27, 2011, at 6:45 PM, Joulesh wrote:

    When I wrote over-sold, I meant over-bought :-)

  • Report this Comment On May 27, 2011, at 7:43 PM, RushBabe49 wrote:

    I would not invest in a company whose product I would not buy. I have to hold my nose every time I need to walk into a Wal Mart. I live 6 blocks away from Costco, and every trip is an adventure. It's also nice to live in the same area, so I can go to the annual shareholder meeting, where they often introduce new items. They treat their employees well, and also their customers. I can't think of a better retail stock to own, especially since they pay dividends too.

  • Report this Comment On May 27, 2011, at 10:02 PM, Bujutsu wrote:

    Costco is wonderful. Not content to just shop there regularly and rave about the store to my friends, I just had to buy Costco's stock too.

    Costco has shown a long-lasting commitment to its shareholders by regular stock buybacks which increase shareholder value. It is also rare to see a growth stock such as this also pay a growing dividend.

  • Report this Comment On May 30, 2011, at 12:43 PM, OGamble wrote:

    Seems to me that once you start going to Costco, you never stop, so they tend to get a lot of repeat business, especially in a sagging economy where more and more people are looking to save cash.

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