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By rclosch
December 26, 2002

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Hartmanbirge posted the following statement.

I am not convinced that this macro squeeze will serve the "warehouse concept" well.

He has raised a really good question, and although I agree with most of what he says, I think I disagree with this statement.

We (my family) live in Orlando on the east side, near the University of Central Florida. It is a new, rapidly growing area that has lately become a microcosm for testing retail trends. We have a Sam's Club, BJ's and Costco. Two Years ago they built a Super Target just down the street and then a Wal-Mart Super center around the corner from the Target.

My wife is a very serious shopper, like the ad says she has a black belt in shopping. Using her as my chief instrument of research I would make the following observations.

FOOD

1. The traditional grocery store � is toast (Probably gets 20% of our food purchases spread about equally between Publix, Winn Dixie. and Albertson's). This is a radical change in my shopping patterns from tens years ago.


2. Warehouse Clubs (about 70% of food purchases, mostly Sam's and Costco), my wife's philosophy "If you can not buy it at Sam's, BJ or Costco you do not need it

Our nearest Costco is just short of two years old. For the first year it was not as busy as Sam's which has been there for quite a while. But we were in Costco Friday and there were long lines at all the checkouts. A stop by Sam's on the way home found it not nears as busy with fewer checkouts open and shorter lines.

3. Wal-Mart Super Center - Too Big, too crowded, takes you three days to find something. By the time you find the item you are looking for you have lost the kid. Then it takes you the next three days to find the kid. Worse yet there is no free lunch.

4. Super Target - same as Wal-Mart but not as crowded, still no free lunch. The quality is better that the Wal-Mart, but the prices are not


5. BJ's is the closest to our house but gets a smallest portion our club business because they really do not have anything that you have not already found at Sam's or Costco, and their free food program is really weak.

Years ago when I first started shopping a Costco I don't remember there being a lot of free food but now if you go to Costco on a Friday afternoon its like a big cocktail party without the booze. I sense the free food samples have become traffic magnet for the Warehouse Clubs. It is a way to get people into their stores before they go to the more traditional stores. Also, it is something that traditional food stores can not offer because without the membership barrier anyone could just walk in off the streets, and it really would be a free lunch.

My feeling is I would not want to be in the traditional grocery business now.

HARD GOODS

Because of the Amount of food we buy at the club stores we are in Sam's or Costco two or three times a week. So they pretty much get first crack at everything else, TVs, computers, vacuum cleaners, tools, office supplies, and lots of other things. If we are buying the first place we look is Costco, if they do not have it, we go to Sam's, only after that does someone else get a shot.

Sunday night we visited the new upscale mall in town with a Macy's, Bloomingdale's and Neiman Marcus. The thought occurred to me that Costco may have a lot of room to move upscale. This is an opinion I don't think that Sam's has because it has a Wal-Mart brain. There was lots nice stuff in these stores but the markup is very high. We saw many things we liked, but I personally would be much more [inclined] to buy these items if I saw them in Costco, because then I would know that the mark up was 12% or so, and that I was buying what I wanted without having to pay for a lot of fancy architecture.

By itself, all this means very little, it is just our experience. And if Costco is going to continue to be successful it is going to have to get millions and millions of other shoppers to change their shopping habits the way they have gotten me to change mine. Can they do that? My guess is they can, but that alone is not going to make it so.

There has been discussion here and on the Berkshire board about Costco's current price and margin of safety, and what is a good entry point. With the consensus of opinion being that while the stock has come down a bunch it still does not have the margin of safety that some would like.

Fifteen years ago I bought my very first stock for my very first client, one share of Berkshire Hathaway for $4400. My timing was terrible, and my understanding of "margin of safety" was nonexistent, because that was 1987 and two months later the market crashed. After the crash we bought another share for $2400 (if only it had been 100 shares.) This time the timing was better because the stock has never been close to that price again.

But here we have two purchases one good one bad. One probably above IV and the other below, but ten years later it made very little difference. Yes the second purchase offered a better rate of return at first but after a while the difference did not matter much.

The point I am trying to make, is that picking a price is not near as important as picking the stock. Even if you can wait and buy the stock at the price you want. It will not be a successful investment if you are wrong about the business; how big is the moat, how honest is the management, and will their business model be successful? These are a lot more important (and more difficult) questions.

In the case of Costco the questions revolve around what I was talking about earlier in this post. Can they continue to take business from Publix, from Albertson's, from Sears from Best Buy from OfficeMax, and all of the mall stores?

If they can do this then it will not matter in ten years if you buy at $27 of at $22. But it will be important to have a position in the stock. Obviously this is a big if. I currently have a position in Costco and so do all my clients, so you know where I stand. But there are no guarantees and though we must bet on the future, we can only guess at what it holds.

A margin is safety is important because it can allow you to exit stock with little damage when you discover you have been wrong about the fundamentals, but it will not turn a bad stock into a good purchase. If you feel that Costco cannot maintain the growth rate of its past it is probably not worth buying at any price.


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