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Why Costco Deserves a Place in Your Portfolio

By Neil Patel – May 19, 2020 at 10:12PM

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Like the products it sells, the warehouse club operator is an essential stock to own.

The ongoing coronavirus pandemic has certainly impacted some companies harder than others. While many stocks are significantly off highs hit earlier this year, Costco (COST 1.76%) has weathered a volatile three months.

As of May 15th, the stock is down only 5% off its all time closing high of $324.08 set on February 20th, compared to the 12% decline of the S&P 500 during the same time period.

Warehouse full of goods.

Image Source: Getty Images

A diamond in the rough

Costco is a rare breed in the retail landscape. Since 2005, the company has had one year with negative comparable sales growth. This was in the depths of the Great Recession in 2009, when same-store sales fell a paltry 4%. Total store count is up 22-fold since 1985, and the last year Costco recorded a net loss on its income statement was 1994! These numbers are impressive in any industry, let alone retail.

But it's not always smooth sailing, as the company's April sales numbers demonstrate. Reported net sales in April showed a rare drop from the prior year, down 1.8%. Obviously this is not all Costco's fault. Stay-at-home orders and social distancing restrictions due to COVID-19 decreased foot traffic to warehouses. However, it's worth noting that April e-commerce sales shot up 85.7% year-over-year. What surprises me about this huge growth is how well Costco's larger products translate to an e-commerce environment. It's clear that members are willing to shift shopping behavior to buy wholesale quantities online. Once states start opening up and things get back to normal, overall sales should continue trending upward.

Members first

Costco's business model is predicated on providing its members high-quality merchandise at low prices. Sounds simple, right? Many retailers promote a similar strategy, but none execute on the same level as Costco. It's all about delighting the customer and keeping them coming back for more. In the American Customer Satisfaction Index (ACSI) Retail and Consumer Shipping Report 2018-2019, which was Costco's first year in the internet retailer category, it beat out Amazon (AMZN 4.50%) to take the top spot for online shopper customer satisfaction. This is remarkable, given e-commerce accounted for only 4% of total company sales in 2019.

Costco is able to leverage its massive scale when bargaining with suppliers, further supporting lower prices. These purchasing efficiencies carry over to distribution and inventory management, as warehouses provide a no-frills atmosphere. The average Costco warehouse is approximately 146,000 square feet, but only carries 3,700 SKUs. The average Walmart (WMT 1.30%) Supercenter, on the other hand, has well over 100,000 SKUs. It is precisely this focus on the most relevant goods that allows Costco to turn inventory quickly and generate high sales volumes.

The basic, Gold Star membership costs $60 a year, a premium when compared to Walmart's (Sam's Club) $45 membership. With a member renewal rate of 88% at the end of 2019, pricing power is on full display here. It all comes back to surprising and delighting customers. Known to have a "treasure hunt" atmosphere, Costco entices shoppers to visit more often and roam the store so they can find outstanding items when they least expect it. Add in the company's extremely generous return policy, and it's very easy to see the superior value proposition being offered.

Time to check out

Although it's difficult to find a perennial winner in the retail space, I've outlined some key attributes that put Costco on that short list. The company is taking a page out of Jeff Bezos' corporate strategy playbook by focusing on the things that don't change. Ten years from now we can be certain that people will still want lower prices, a better selection, and a better experience, all elements Costco strives at.

The company currently sports a PE ratio of 36, which at first glance doesn't necessarily scream value. However, Costco is an exceptional business that's easy to understand and has passionately loyal fans. I wouldn't argue against making a small entry purchase here, with the objective of waiting for a pullback in the stock to take a more meaningful position to hold for the long-term. Costco is notorious for delivering immense value to its customers. I see no reason why the stock can't do the same for shareholders.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Neil Patel has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Costco Wholesale and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
COST
$486.13 (1.76%) $8.40
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$121.09 (4.50%) $5.21
Walmart Stock Quote
Walmart
WMT
$134.25 (1.30%) $1.72

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