Has Costco Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Costco Wholesale (Nasdaq: COST  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Costco.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

9%

Fail

 

1-Year Revenue Growth > 12%

11.5%

Fail

Margins

Gross Margin > 35%

12.4%

Fail

 

Net Margin > 15%

1.7%

Fail

Balance Sheet

Debt to Equity < 50%

12.5%

Pass

 

Current Ratio > 1.3

1.10

Fail

Opportunities

Return on Equity > 15%

14.1%

Fail

Valuation

Normalized P/E < 20

25.69

Fail

Dividends

Current Yield > 2%

1.1%

Fail

 

5-Year Dividend Growth > 10%

13.4%

Pass

       
 

Total Score

 

2 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Costco last year, the company gave back the point it picked up between 2010 and 2011. Revenue growth slowed slightly, but that didn't stop the stock from posting a gain of about 15% over the past year.

Costco has turned the warehouse retail model into a huge success story over the decades. With even traditionally successful big-box retailers Best Buy (NYSE: BBY  ) and Staples (Nasdaq: SPLS  ) running into big problems due to competition from online giant Amazon.com (Nasdaq: AMZN  ) , Costco largely avoids the same issues by keeping margins razor-thin and by selling bulk quantities that are in many cases impractical to ship.

Because of its retail strength, Costco is able to make mutually beneficial agreements with suppliers. For instance, Green Mountain Coffee Roasters (Nasdaq: GMCR  ) entered into a deal earlier this month with Costco to provide coffee for its Kirkland Signature store brand. The deal will have Green Mountain making K-Cups for use in its Keurig single-cup brewer, potentially helping the coffee company break out of its recent tumble.

Still, not everything is perfect for Costco. It underperformed its projections for same-store sales gains during the summer, and economic woes could lead to shoppers cutting back.

After its most recent quarterly report, though, Costco hit an all-time high. Its 86% membership retention rate even with recent price increases for annual memberships shows its strength, especially given that membership-fee revenue accounts for 75% to 80% of operating profits.

With its emphasis on low prices, Costco will never reach perfection on this 10-point scale. But if the economy improves, Costco should improve along with it.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate the best investments from the rest.

Costco is king of wholesale clubs, but everyone knows Amazon is the big bad wolf in the retail world right now. At its sky-high valuation, most investors are worried it's the company's share price that will get knocked down instead of competitors'. We'll tell you what's driving the company's growth, and how to know whether to buy or sell Amazon in our new premium report. Our report also has you covered with a full year of free analyst updates to keep you informed as the company's story changes, so click here now to read more.

Click here to add Costco to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.


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