What Makes Costco Successful?

Costco has enjoyed stock appreciation of 76% over a three-year time frame. Future stock appreciation is likely. But what makes Costco successful? You need to know what you’re investing in before choosing this retailer over competitors Wal-Mart Stores and Target Corp.

Jan 18, 2014 at 9:00AM

Much of the reason for Costco Wholesale's (NASDAQ:COST) success is differentiation. A Gold Membership at Costco costs $55 per year. This might turn off some consumers, but it shouldn't. It's highly likely that the $55 investment will be made up by a wide margin thanks to consistent savings. This, in turn, is what makes Costco so appealing to consumers. And if a retailer is appealing to consumers, it's going to be appealing to investors. 

Target market
On top of the average membership costing $55 per year, Costco only accepts certain forms of payment, including cash, checks, debit cards, and American Express credit cards. Since many consumers need to rely on credit cards for spending on everyday items, and being that American Express has a predominantly high-end clientele, most Costco customers (or members) are well off financially. Therefore, many of these customers have more discretionary spending power than customers at the average discount retailer, which is a big positive for Costco.

Outperforming Target and Wal-Mart
Though not a membership retailer, Target (NYSE:TGT) also attracts a higher-end customer base than most discount retailers. This has a lot to do with Target locations and the appeal of the store ranging from cleanliness to orderly shelving. Unlike Costco, Target doesn't take a warehousing approach to its business. Costco relies on volume in order to pass along steep discounts to its customers. This is why Target has a higher profit margin of about 3.3% compared to Costco at 1.9%.

That said, there's nothing wrong with either business model. They're just different. What really matters is growth, and while Target has seen top-line growth of 13.6% over the past five years, Costco has blown that number away, growing at a 45.9% clip over the same time frame.

The one real edge for investing in Target is that it currently yields 2.7%, whereas Costco yields just 1.1%. However, if Costco continues to grow at the rate it's growing now, stock appreciation potential for Costco will greatly exceed that of Target's. And while it's becoming an overly redundant topic, also consider Target's data-breach situation, which could negatively impact Target's business and stock price short term.

Wal-Mart Stores (NYSE:WMT) also sports a higher profit margin than Target, at 3.6%. And it has outperformed Target on the top line over the past five years, seeing growth of 17.5%. However, that's still nothing compared to Costco. The advantage to investing in Wal-Mart is consistent and trustworthy capital returns to shareholders. Wal-Mart currently yields 2.4%, and it's always buying back shares. Costco might not offer as much in the form of capital returns to shareholders, but it's steady across the board and it offers more growth potential.

A unique approach
We have established that Costco is all about volume. But what makes this company's approach so intriguing is that it literally drops its shipping pallets on the warehouse floor, which customers than explore, determining what products interest them most. For the record, a shipping pallet is a flat structure with goods on it that is transported from one site to another. By avoiding the process of unloading and opening boxes, and then shelving, Costco cuts out huge unnecessary costs, and those savings can then be passed on to customers.

Many consumers don't know this, but Costco also carries designer brands. While Costco shouldn't be seen as a go-to retailer for designer brands, it should be seen as a place where you can sometimes find substantial discounts on high-end merchandise.

It should also be noted that approximately 20% of Costco's products are the private-label Kirkland brand. Aside from being available on Amazon.com, Kirkland is exclusive to Costco. I'm not a Costco member since there is no convenient location, but I do own a Kirkland t-shirt. It's thick, durable, and comfortable, and of higher quality than most (possibly all) t-shirts you will find at Target or Wal-Mart.

All exciting, but the real traffic driver for Costco is food. Of course, some consumers shop in other areas of the store before or after they shop for food.  And for the record, Costco sells an average of 109 million hot dog/soda combinations per year. For $1.50 total, who wouldn't take advantage of that deal while shopping?

The bottom line
Costco's business model works well in today's economic environment. Not only does it target the value-conscious consumer, but this value-conscious consumer also brings spending power to the table. Barring any economic calamities, Costco should continue to outperform Target and Wal-Mart, both on Main Street and Wall Street. 

6 More Amazing Growth Picks From The Motley Fool
They said it couldn't be done. But David Gardner has proved them wrong time, and time, and time again with stock returns like 926%, 2,239%, and 4,371%. In fact, just recently one of his favorite stocks became a 100-bagger. And he's ready to do it again. You can uncover his scientific approach to crushing the market and his carefully chosen 6 picks for ultimate growth instantly, because he's making this premium report free for you today. Click here now for access.

Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information