Owners of Costco (NASDAQ: COST ) stock should rest assured: When Costco releases its earnings Wednesday, it will be more of the same for the ever-growing retailer. Investors don't need a crystal ball to know that Costco will, once again, post increases in sales. And with a business like Costco, an increase in sales means increases in earnings and members.
Costco is dutiful in keeping investors up to speed every month, so quarterly or even annual results never come out of the blue. Last month, Costco reported that its fiscal-year 2013 sales were up about 6% from last year. With most retail businesses, higher sales automatically mean higher profits, but that's not Costco's model. Costco sells its wares at close to a zero margin, charging customers for a product about what it costs for the retailer to buy that product and stock it in its stores. Rather than charging a mark-up on retail sales, Costco earns its profits by charging its customers an annual fee to shop at its stores.
However, even though Costco stockholders don't directly benefit from higher sales, in practice higher sales have meant one (or both) of two things for Costco: more members or more valuable members. Costco sells more goods either when it recruits more members, which means more membership fees generating profit, or when existing members are buying more. Costco has a two-tiered membership model in which basic members can pay $55 annually, but high-volume shoppers can opt for a $110 executive membership that comes with more perks. In its most mature, saturated markets, Costco has generated higher operating profits less by recruiting additional new members, and more by upselling existing members to executive memberships. In these markets, executive members make up just a third of all members but contribute half of all profits and, due to their higher spending habits, an even greater share of sales.
So, even though Costco's higher sales don't directly drop to the bottom line, in Costco's history higher sales have always led to better profits. Higher sales are even a good predictor of good member retention rates, which have ticked up ever closer to 90% over 2013, from 89.7% to 89.9% in recent quarters.
The long and short of it is that regardless of the specifics of the release on Wednesday, what we know about higher sales means that investors will almost certainly be greeted with higher earnings in Costco's core markets. The only question remaining will be how well Costco's new international stores have performed. With the company reaching saturation in its American and Canadian markets, Costco's easiest pathway to growth is through replicating its North American success internationally.
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