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What Costco Investors Should Know About Last Week's Gains

By Motley Fool Staff - Apr 12, 2017 at 7:22AM

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Monthly sales outpaced analyst expectations in March.

In this segment from Motley Fool Money, Chris Hill is joined by Jason Moser and Simon Erickson as they discuss the outlook for discount warehouse club Costco (COST 0.94%), which put up impressive sales numbers in March.

The retailer has loyal members, but how long will its business model last in the face of the ongoing e-commerce revolution? And more important for Foolish investors, can the business catch up with its optimistic share price?

A full transcript follows the video.

This video was recorded on April 7, 2017.

Chris Hill: Shares of Costco up this week after same-store sales in March rose 6%. That is higher than Wall Street was expecting. Jason, net sales in March also up 9%. I know you were a little, dare I say bearish on Costco, on a recent episode of Motley Fool Money. But they're looking pretty good, at least in terms of what they were doing in March.

Jason Moser: Yeah, I think this is good news. I like the Costco business. I'm a little bit less enthused on the investment. But consumers are on a bit of a stronger footing today. Costco's strength has always been in its loyal membership base, and taking care of their members first and foremost. They continue to do a very good job with that. I think the bigger question remains: How much more can they expect to grow that membership base over time here, as e-commerce becomes more and more the norm?

Again, I think it's a good business, but when you look at the direction people are headed, they value their time more today than they did, perhaps, 10 or 20 years ago. And that's where Costco, I think, could run into a little bit of a problem. They're also trying to figure out ways to upgrade that membership base to get more executive members. Executive members, as we've talked about before, represent 36% of the actual member base but a full two-thirds of the company's total sales. Those are very valuable members, and they have to figure out a way to grow that membership base, that existing base. Because I don't see that existing subscriber base really growing much more from today's numbers.

Simon Erickson: I'm just a fan of the free samples. Going to Costco, you can make a day out of that, just going for the free samples they give out.

Moser: And I don't mean to offend Mac Greer here, because I know Mac is a Costco fanatic. And I love that about you, Mac, don't get me wrong. But I think you have to separate the business from the stock. I like the business. I'm not a member, but I respect the business. But you have to look at the stock and the valuation. They're still trading at better than 30 times earnings. This is a company that, over the past three years, has grown its earnings on an annualized rate of about 7%. That's a huge disconnect. And what the market is saying is, they respect the fact that Costco is a very strong business with a strong membership model. But again, I think the stock, it's going to be very difficult to perform from today's prices, given what we know about the forward-looking picture.

Hill: Maybe boost profits by cutting back on the free samples.

Moser: Or get Mac there one more day a week.

Chris Hill has no position in any stocks mentioned. Jason Moser has no position in any stocks mentioned. Simon Erickson has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale. The Motley Fool has a disclosure policy.

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