3 Reasons to Buy Costco

A high-quality business model, rock-solid customer loyalty, and the company´s ability to outperform competitors through good and bad times are three strong reasons to buy Costco.

Mar 28, 2014 at 6:00PM

Cost Image

Source: Costco

Investors in Costco (NASDAQ:COST) may be disappointed after the company reported lower than expected earnings for the second quarter of fiscal 2014. However, the retailer still benefits from a smart and innovative business model that generates consistent loyalty from customers, and the company is outperforming competitors such as Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) by a considerable margin. The recent weakness in Costco looks more like a buying opportunity than a reason to panic.

A high-quality business model
Costco makes most of its profit from membership fees, not margins on product sales. This means Costco can sell its products at cost, or sometimes even at loss, which provides a remarkable source of competitive strength in the discount retail sector where price is a central factor for success.

For perspective, while Wal-Mart earns a gross profit margin in the area of 25% of sales, and Target has had a gross margin in the neighborhood of 30% in recent years, Costco sells its products for a materially lower gross margin close to 12.5%.  

As the company grows in size, it gains purchasing power with suppliers, which allows Costco to negotiate better prices and financial conditions for its products. Besides, economies of scale and supply chain efficiencies generate additional cost savings as sales volume expands.

While the company gains more members and sells more products over the years, it should generate additional cost advantages which will likely translate into amazingly low prices for customers. The more successful Costco is on the commercial side of the business, the larger the savings it can pass on to customers. This produces a self-sustaining virtuous cycle by which the service provided by Costco becomes more valuable as the company becomes bigger over time.

Also, Costco collects most of its membership fees in advance, reducing volatility and dependence on sales volumes when it comes to generating cash flow and profitability for shareholders.

Rock-solid customer loyalty
The retail industry is notoriously competitive, but Costco stands away from its rivals thanks to its particularly loyal customer base. Retention rates are usually above 85% on a global basis and more than 90% in big markets such as the U.S. and Canada. Customers seems to be quite satisfied with Costco and its value proposition.

Even though sales and earnings came in below Wall-Street expectations during the quarter ended on Feb. 16, the company is still as solid as ever in terms of customer loyalty and membership renewals. The global renewal rate was 86.4% during the period, and new memberships increased by 13% versus the same quarter in the prior year.

Membership fees grew by 4% to $550 million during the quarter, but negative currency effects represented a considerable drag on performance. Membership fees excluding foreign exchange impact increased by a much stronger 7% annually to $563 million.

Outgrowing the competition
Costco has materially outperformed competitors such as Target and Wal-Mart in the last few years, and recent financial reports suggest no 
reversal in the trend.

During the 24 weeks ended on Feb. 16, Costco produced a healthy increase of 5% in total comparable-store sales when excluding gasoline prices and exchange rate fluctuations. Comparable-store sales in the U.S. increased by 5%, while corresponding revenue in international markets grew by 7%.

Wal-Mart, on the other hand, announced a decline of 0.4% in U.S. comparable-store sales excluding fuel during the 14 weeks ended on Jan. 31, while comparable-store sales excluding fuel at Sam´s Club fell by 0.1% during the period.

Target was hurt by the holiday season data breach, so performance was quite dismal during the quarter ended on Feb. 1. Total sales fell 3.8% versus the prior year, with the main driver of the decline being a 2.5% fall in comparable-store sales in the U.S.

Even if Costco has been affected by factors such as currency headwinds and harsh weather conditions lately, the company continues to gain market share versus the competition. In a mature and competitive industry such as discount retail, in which one company´s gain is usually another's loss, betting on the winners is of utmost importance.

Foolish takeaway
An innovative and smart business model, outstanding customer loyalty, and the company´s ability to outperform the competition through good and bad economic times make Costco an extraordinary player in the discount retail business. Investors have no reasons to panic about the recent weakness in performance; if anything, short-term pullbacks could provide a buying opportunity for long-term investors.

3 stocks to own for the rest of your life
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love. 

 

Andrés Cardenal 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers