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Wall Street analysts tend to be one-dimensional, focusing on esoteric data while ignoring common sense. In the process, they often miss the market's best opportunities.

This is great news, of course, for investors like Warren Buffett and Peter Lynch, who get rich by rejecting facts and figures in favor of investing in what they know.

The best stock in today's market fits this model like a glove. While some Wall Street analysts reject it as "the world's largest co-op," it has stacked up staggering returns for its shareholders. And in my view, Wall Street's closed-minded approach to this company makes now a great time to invest in its shares.

Costco: The Wall Street pariah
Wall Street's problem with Costco (Nasdaq: COST  ) stems from its business model. According to conventional wisdom, Costco's commitment to low prices rewards customers, but hurts shareholders. Costco's gross margin, one of the most important statistics in all of retail, seems to bear this out.

As I discussed in a previous article, gross margin indicates both potential profitability and brand power. It's the portion of sales left after a company pays for all the costs directly attributable to producing (or, in the case of a retailer, obtaining) the goods it sells.


As you can see, it's hard to argue with Wall Street's logic here. Its low prices leave Costco's gross margin dwarfed by those of its close competitors Wal-Mart (NYSE: WMT  ) and Target (NYSE: TGT  ) . This apparent disadvantage seems even steeper when you compare Costco to more specialized retailers like Office Depot (NYSE: ODP  ) , Radio Shack (NYSE: RSH  ) , and Staples (Nasdaq: SPLS  ) . Indeed, of the retailers I examined, Costco's gross margin only compares well against that of BJ's Wholesale Club (NYSE: BJ  ) .

Turning of the tides
Fortunately for contrarians, Wall Street largely overlooks one key fact: The same low prices that squeeze Costco's gross margins also contribute directly to its exceptional growth. In the last five years alone, Costco grew its membership base by 25%. Much of that growth took place in the depths of the Great Recession.

Costco subsequently translated this expansion into higher same-store sales, the creme de la creme of retail statistics. Indeed, despite the recession, Costco's same-store sales increased by 5% annually -- five times the rate of Wal-Mart and Target.

What about shareholders?
Flying in the face of Wall Street's scorn, Costco's low-margin/high-growth model has enjoyed amazing success in increasing shareholder value. As you can see, its 10-year compound annual growth rate trounces both its competitors and the market's:

Source: Yahoo! Finance.

If you'd purchased Costco shares 10 years ago, you would have almost tripled your money! That's quite a bit better than the S&P 500 index's near-flat performance over the same period.

The contrarian view
By proving Wall Street skeptics wrong, Costco reaffirmed its merit to all contrarian investors. That's why Costco is one of only two retailers our analysts recommend in their free report "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail," which discusses how innovative retailers are actually growing revenue and making shareholders rich even in these difficult times.

Fool contributor John Maxfield does not hold positions in any of the companies mentioned in this article. The Motley Fool owns shares of Costco, Wal-Mart, and RadioShack. Motley Fool newsletter services have recommended buying shares of Costco, Staples, and Wal-Mart, as well as creating a diagonal call position in Wal-Mart Stores. 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.

Read/Post Comments (3) | Recommend This Article (20)

Comments from our Foolish Readers

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 September 20, 2011, at 6:14 PM, BenFE08 wrote:

    Costco's success is because of one thing - they care about the customers FIRST, and the stockholders 2nd. It's a simple no-brainer.

  • Report this Comment On September 20, 2011, at 6:34 PM, DoctorLewis4 wrote:

    Finally someone gets Costco! It's the cornerstone of my portfolio. When it dips I buy more.

  • Report this Comment On September 23, 2011, at 7:04 PM, rhuntjr wrote:

    I get it. Radioshack is not exciting. It doesn't sell anything cool. It doesn't have a flagship 5th avenue location. Nobody ever goes there unless they absolutely have to.

    But look at the first chart--RSH has the highest gross margins by far. And RSH doesn't just compare well to its peers. Somewhat surprisingly, the company's business model is stronger than 80% of the companies in the Russell 3000, as evidenced by its 14% return on invested capital. Furthermore, these returns are stable. The company has generated a return on capital greater than its cost of capital in each of the past ten years--less than 9% of R3K companies have achieved that in the past decade.

    RSH isn't just a strong performer--the stock is also a fantastic bargain. In fact, the current stock price implies that RSH's cash flows will fall by 60% and stay there forever. Any performance over this low hurdle will greatly reward RSH investors.

    The only way to make money in the market is to buy low expectations and sell high expectations. Right now, expectations don't get much lower than RSH's.

    If you want to know more about understanding market expectations, this site is great place to start:

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