Costco Wholesale (COST 1.01%) isn't exactly a high-yield stock, but what it lacks in yield, it makes up for in dividend growth. It has increased its payment for 19 years and counting, with the average annual dividend boost over the past decade sitting at a heady 12%. Those two stats are built on what is now a customer foundation worth $4.5-billion-plus annually. Here's what you need to know about Costco's secret weapon.
Costco isn't like most retailers
Every retailer will tell you that customer satisfaction is important. Customers don't return to stores that upset or anger them. But Costco isn't any old retailer; it is a club store that charges a membership fee. So in order to shop at Costco, a customer has to dole out some cash before they can even buy anything.
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This is a big model shift. Costco has to go above and beyond to keep its customers happy because otherwise, they will cancel their memberships. One of the biggest ways that Costco keeps members satisfied is by keeping the cost of the products it sells low. But it goes beyond that. For example, the company is known for treating its employees well so that the employees, in turn, create an enjoyable shopping experience for customers.
A great example of how important customers are to Costco occurred during the supply-chain disruptions caused by the coronavirus pandemic. The retailer temporarily created a shipping fleet so it could ensure that it would have products on its shelves when members showed up at its stores. This effort was a time-consuming and costly one, notably requiring a write-down when the arrangement was unwound. While this move was clearly about making money, the real impetus was to make sure its members remained satisfied with their memberships at a time when other retailers had empty shelves.
A $4.5 billion (and growing) secret weapon
From a revenue perspective, the roughly $4.5 billion that Costco collected in membership fees in fiscal 2023 was dwarfed by its $237.7 billion in product sales. At first glance, membership fees would seem like an afterthought. However, these two figures aren't the full picture.
The company's cost to attain that membership revenue is virtually nothing. The cost of the products Costco sells is around $212.5 billion. And selling, general, and administrative costs (basically what it costs to run the stores) is $21.5 billion or so. To figure out how much Costco really makes from its stores, you need to subtract these two expenses from the store revenue, which comes out to about $3.5 billion. So memberships generated $4.5 billion but the stores themselves only really made $3.5 billion or so.
Suddenly that $4.5 billion in membership fees looks a lot more important. And it is those fees that allow Costco to be aggressive on product prices. Yes, it has to accept lower margins when it sells products. But the membership fees make up for that, and the low product prices keep those fees rolling in.
As the company opens new locations, investors shouldn't be thinking about the revenue that will be generated. Instead, investors should be thinking about the new members that will be added. There were 73.4 million North American household memberships at the end of the fiscal second quarter of 2024. And when the company reports results, another vital figure to watch for is the renewal rate, which stood at 92.9% for North America in the fiscal Q2 2024.
That's not meant to suggest that product sales and operating costs aren't important. It's just that the results on the membership side of the equation are at least equally, if not a little more, important.
Costco stock is always expensive
Costco's dividend yield is tiny at 0.5%, largely thanks to its long history of successful growth. Value investors and those trying to maximize the income they generate probably won't find it attractive. However, dividend-growth investors and growth-and-income investors should have this retailer on their wish list (if not their buy list). And the big secret -- that's really not so secret -- is the $4.5 billion-plus in membership fees that underpin the company's business model.
