This Stock Will Hold Up Your Portfolio

It’s the end of Fiscal Fitness month here at the Fool, and many of you should have at least $2,000 saved. How about socking that $2,000 into a stock?

Here’s one idea: Costco, which is currently one of Motley Fool Inside Value’s Best Buys Now.

The Costco Way
Costco (NASDAQ:COST) is an exemplary discount retailer with the potential to excel in good or bad times. It offers discount bulk goods in a warehouse setting, putting aside excess expensive frills like bagging, credit cards (which charge retailers fees), or posh, comfortable surroundings. Lowering costs of doing business helps Costco keep prices so low.

Part of Costco’s business model – and an additional revenue stream -- is to charge yearly membership fees to its customers, many of which are small business owners. That’s the price of admission to get in and get the awesome deals.

One of Costco’s major strengths is its deft inventory management. Costco rotates merchandise in and out of the store in a dynamic fashion, reacting to demand and what products it can offer at the best prices. The fact that some coveted items may not be available next time gives the “treasure hunt” effect, which has been known to compel shoppers to snap things up since they know these items may not be there on their next trip.

Costco is also known for treating its workers very well, providing them with good benefits such as health insurance and believing the ideal that treating employees well is good business practice for the long haul. This has helped it be one of the rare retailers that excel at employee retention.

Costco vs. the industry
Let’s take a look at some interesting metrics and compare Costco, a four-star stock in Motley Fool CAPS, with the rest of its industry.

Data from CAPS as of 1/29/09.

Investing Thesis
Costco has always struck me as a solid company for the long term. CEO Jim Sinegal is one of those very Foolish CEOs who cares more about running a good, solid, long-term business than about his own personal aggrandizement or bank account. He is modestly compensated, and the stories about his management style include personal visits to Costco stores 200 days in the year to see how things are going in person. In other words, he's a down-to-earth guy, who is utterly immersed and hands-on in the business. It wouldn’t be much of a stretch to compare him to another master of common sense and good business practice, Berkshire Hathway’s (NYSE:BRK-A) (NYSE:BRK-B) Warren Buffett. These aren’t the kind of guys who decorate their offices with $1,400 trash cans.

Right now, though, the most compelling thing about Costco as an investment is that it is one of the retailers that should be able to thrive in these difficult times, since its stock-and-trade is providing good deals to today’s nervous consumers. Like Wal-Mart (NYSE:WMT), Costco is known for bargains, although Costco often throws in higher end merchandise at cut-rate prices, adding to its overall allure.

Costco’s shares fell almost 25% in 2008. It’s trading at 16 times earnings, and while that may sound like a premium when so many retailers are trading at single-digit price-to-earnings ratios, that premium is worth it for a well-run company that’s positioned for economically challenging times.

Costco has a clean balance sheet; its total cash of $2.8 billion translates into almost $6.50 per share in cash. Its debt-to-equity ratio is a manageable 26.7%, unlike many retailers that should be avoided due to their scary debt levels. (I recently called out Bon-Ton (NASDAQ:BONT), Pier 1 (NYSE:PIR), and Rite-Aid (NYSE:RAD) as among the ones that should be on death watch.) It also generates ample free cash flow.

Meanwhile, Costco has a dividend yield of 1.30% to further sweeten the deal.

Could Costco prove costly?
No investment is risk-free, of course. It’s possible that the economy could get so ugly that Costco members might begin to economize in an unforeseen manner and decide the yearly fee is too much. Costco’s cash (or debit) only business might also drive some financially pinched customers away, or they might balk at its tendency to provide bulk items.

Even more ominously, there is the possibility that some of its small-business customers may need to buy less at Costco due to their own waning demand, or may go out of business altogether (yikes).

Wall Street analysts in the past have criticized Costco for not boosting profitability by skimping on things like employee benefits. To my way of thinking, this is one of Costco’s competitive strengths, but investors might balk at its refusal to juice short-term profits, which could always put near-term pressure on the stock.

Who should consider Costco?
I think Costco’s a great stock idea for any long-term portfolio. Costco is a high-quality retailer that is easy to understand; most of us can think of a Costco within a short distance of home or work, and may even be frequent customers. It’s a perfect stock for beginning investors who are looking for a stock they can have and hold, and one that’s simple, well run, has an awesome brand and management team, and a strong balance sheet, to boot.

There are two more stocks that we’re sharing with our readers of the Fiscal Fitness challenge – now that you’ve saved up $2,000. Click here to discover their identities, as well as check out the rest of the Challenge's money-saving tips.