When you duel with the best, you have to expect a hard fight. Rich, you built a highly persuasive case regarding Costco (NASDAQ:COST) -- congratulations! My only rebuttal is that in retail, I've learned you have to get your numbers right, then dig behind them to ensure they tell the real story. Sorry, yours don't.

Are Costco's margins really declining?
Careful examination says no. Your bear rebuttal shows a time series of trailing-12-month net earnings margin. What you missed is that during the last quarter of 2005, Costco reported a sizable one-time tax benefit. In the most recent two quarters, the company has taken unusual charges for increases to its sales return reserve. The return policy has been tightened, so these are one-time events also. Adjusting for unusual items, we get to the true underlying earnings percentages.





Sales (in millions)





Net Earnings (in millions)





Net Earnings





*TTM excludes unusual sales return reserve adjustments.
**2005 excludes unusual tax benefit.

These operating margins look pretty stable to me, with a 6-basis-point gap between the highest and lowest net margin over the last three and three-quarters years. By the way, adjusting TTM earnings for the sales return reserve impact lowers the P/E ratio from 24 to 22. I admit that's still a premium to Wal-Mart (NYSE:WMT) or Target (NYSE:TGT).

Is Costco worth the premium?
Timing is everything. Yesterday, all three companies reported May comparable sales. As usual, Costco had the best. But dig deeper to understand the real economics of these sales releases, extrapolated out to a full year. Let's put one store from each company in a hypothetical town ... call it Foolville, USA.




Annual sales/store (in millions)




May comps




Annual sales increase (in millions)




*Wal-Mart comps are Wal-Mart segment, excluding Sam's Club.

Voila ... percentages meet real dollars. These May results (which are pretty representative of recent history) show the Costco store gaining $8.9 million in volume for the year, compared to the $2.4 million and $0.2 million for the Target and Wal-Mart stores respectively. Yes, Costco's margin rate is lower -- that's the whole point. Substantially higher sales volume per store allows it to capture the largest increase in margin dollars, creating more value for shareholders. This is what savvy investors understand, and why they pay a premium to own the Costco store. I rest my case.

You're not done yet! If you missed any of the other arguments, they're here. If you've already read everything, cast your vote for the winner here.

Costco is a Motley Fool Stock Advisor selection. Wal-Mart is a Motley Fool Inside Value recommendation.

Motley Fool contributor Timothy M. Otte surveys the retail scene from Dallas. He welcomes comments on his articles, and owns shares of Costco and Wal-Mart. The Fool has a disclosure policy.