In a bear market, some investors may try to quickly shift some of their funds from risky and plummeting growth stocks to more stable and secure value stocks. But all this reshuffling ignores a crucial part of long-term investing success: identifying long-term winners and then holding on through the short-term ups and downs.
Costco Wholesale (COST -0.24%) and American Express (AXP 6.22%) are two excellent stocks that have seen their shares slip a bit in recent months but have beaten the market over the past five years. They also share something that make them no-brainer stocks to own in any market. Here's their secret: a fee-based business model. Let's explore why that makes them so compelling.
Costco: Membership pays
Costco has been posting phenomenal performance since the pandemic began. It has outperformed competing discount retail chains such as Walmart and Target this year in sales growth as they all face inflation and high comparable sales growth from the early stages of the pandemic.
Costco's formula is simple but powerful. It charges a yearly membership fee of $60 for cardmembers, which gives them access to Costco's warehouses.
If at first it seems like customers would balk at having to pay for the opportunity to shop at Costco, consider that global renewal rates typically come in at around 90% and slightly higher in the U.S. and Canada. They reached record highs in the 2022 fiscal fourth quarter (ended Aug. 28). There were 65.8 million member households and 118.9 million cardmembers in the fourth quarter, up 6.5% from last year. At the same time, store count increased 3%.
Executive members pay $120 for an annual membership. This gets them two cards, special discounts, and a 2% annual reward. Executive members account for 44% of the total and 72% of sales. Membership fee income was $1.3 billion in the fourth quarter.
Members find membership worthwhile because Costco prices are that much cheaper than other stores. Gross margin is typically around 11%, but it was closer to 10% in the fourth quarter. Management works hard to keep prices down under any circumstances, and it greatly expanded its direct supply chain over the past year to circumvent logjams. This helps it keep costs, and prices, down. It also sets the stage for greater efficiency in the future, even after current world problems make an exit.
Despite margin pressure, earnings per share rose from $3.76 last year to $4.20 this year in the fourth quarter. Costco's differentiated approach to discount shopping makes it a winner in any economy and a no-brainer addition to a diversified portfolio.
American Express: Cardmembers get perks
American Express is a completely different kind of business from Costco, but it shares the fee-based model. Cardholders may pay an annual fee ranging from $25 for a basic card to $700 for the highest tier. As outrageous as that may sound, high-tier cardholders rave about the perks that fit their lifestyle.
Despite a volatile economy, American Express saw record card acquisitions for many of its cards in the second quarter, and CEO Stephen Squeri said new members were "highly engaged" with member benefits. Its cards attract users with quality credit profiles, which means it will have fewer defaults. The fee-based model appeals to a more affluent crowd that can afford to pay the annual fee and appreciates the perks. And it also pads both the top and bottom lines, making it an important part of the business model.
Card fees typically grow at about 10% year over year, but that jumped to 19% in the second quarter.
American Express card fee growth. Image source: American Express.
Card fees were $1.5 billion, or 11% of total sales of $13.4 billion. Total revenue increased 31% in the second quarter, outpacing non-fee-based Visa and Mastercard over a similar time period.
The Warren Buffett favorite is down 14% this year and trades at a low 14 times trailing-12-month earnings. It's a great choice for consistent future growth.
