The Power of Earnings: Costco

Chartists, momentum investors, and palm readers may disagree, but at The Motley Fool, we know that a stock is worth only the cash flow its underlying business generates. But as investors, how do we know if we're buying those cash flows on the cheap or if we're paying too much for future expectations?

Try using the earnings power value, a quick way to calculate the value of a company's current earnings. Once we've crunched the numbers, we can then compare the EPV to a company's stock price to determine the value that investors are giving its earnings growth. Then you can make the call if it's worth paying up for that future growth.

If you're new to the EPV way, check out our primer here. Don't worry: You don't need a Ph.D. in finance -- just a few numbers you can easily find at Fool.com. Let’s take a quick look at the EPV for Costco (Nasdaq: COST).

First: What it does
With a product selection that includes everything from cheap diapers to diamonds, Costco's got you covered. The company operates 569 membership warehouses across the U.S., Canada, Mexico, and abroad, and offers a dizzying range of merchandise at heavily discounted prices.

Most people think of Costco as a big-box retailer -- but it’s also a tollbooth. That's because Costco's business model relies heavily on the collection of annual club membership fees. Last year, the company generated more than $1.5 billion in fees from its 56 million members.

Second: The value of today's earnings
Using our handy EPV primer from above and a 10% discount rate, we get the following for Costco:

TTM = trailing 12 months.

Third: Is it worth it?
We're not surprised to see that growth accounts for about 16% of Costco's stock price. Costco has been a steady (but not stellar) grower over the past five years, increasing revenues by 8% per year and earnings per share by about 6% per year. Costco will continue to bring in new warehouse members each year, in addition to opening new stores.

Analysts expect 15% earnings growth this year and 11% growth next year. This might be aggressive, but as we emerge from the recessionary environment of the previous year, we think Jim Sinegal, Costco’s CEO and one of the best operators in the business, is just the right guy to lead Costco to this type of future growth.

Fourth: Costco’s EPV versus three competitors'
Let’s see how Costco stacks up against three other companies playing in the discount retailer space. Running these three companies through our EPV calculator gets us:

Interestingly, Costco’s current stock price appears to be relying on growth more than other companies in the discount retailing industry. Remember, EPV is a handy tool to see what price investors are putting on a company’s future. But it’s just a starting point. I think Costco is one of the finest-run companies in America, and we should see nice growth for years to come. Do you agree? Let us know which stock looks best to you by posting your opinion below.