Now that Costco Wholesale Corporation (NASDAQ:COST) has reported its Q3 results for the 2014 fiscal year, investors are starting to ask, "Is now a good time to buy shares of Costco?"
A few pundits are putting up caution flags. Some point to Costco's above-market valuation along with the fact that earnings growth has tailed off lately. Others argue that Costco stock has run out of momentum. Indeed, Costco stock has been chopping around near its current level for the past year.
However, these analyses miss the point. Costco has by far the lowest operating costs in the retail industry, allowing it to offer the lowest prices. This creates a huge "moat" for Costco and helps it consistently gain market share. In the long run, this will lead to solid earnings growth. As a result, it's always a good time to buy Costco stock!
Trouble in the retail world
In his 1990 investor letter, legendary stock-picker Warren Buffett noted that Wal-Mart (NYSE:WMT) "with its 15% operating costs, sells at prices that high-cost competitors can't touch and thereby constantly increases its market share."
For nearly two decades after Buffett made that remark, Wal-Mart continued bulldozing its way through the retail industry. In the process, it went from having just over $30 billion of annual revenue in 1990 to a stunning $370 billion in revenue in 2007.
The Great Recession put a stop to Wal-Mart's growth, though. Wal-Mart relies heavily on low- and middle-income consumers to drive sales, and those people have had a really rough time since 2008. As a result, many Wal-Mart customers are cutting back on personal spending. They are also finding good deals at dollar stores that are more conveniently located.
But Costco keeps on growing!
By contrast, Costco has a much wealthier clientele. It costs $55/year for a basic membership, which is enough to turn away anybody who is really living paycheck-to-paycheck. However, that $55 fee is a ticket to huge savings on a wide variety of items. Costco's operating costs are less than 10% of net sales, allowing the company to limit markups to 14%-15% at most -- and just 11% on average.
In many ways, Costco has taken the Wal-Mart business model (use low operating costs to reduce prices and gain market share) to its logical extreme. By being the absolute lowest-cost retailer, Costco doesn't have to worry too much about the long-term threat from e-commerce or anything else. There will always be plenty of people looking for the best price.
So far, it's hard to argue with the results Costco is delivering. In the last 5 years, Costco's revenue has jumped more than 50%, while Wal-Mart's total revenue has risen less than 20% in the same period.
Costco's revenue growth remains as solid as ever. Last quarter, excluding the impact of foreign exchange and gasoline price fluctuations, Costco's comparable store sales rose 6%. Meanwhile, Costco is growing its warehouse count by 4%-5% each year.
Best of all, Costco has plenty of room for growth going forward. Of its 655 warehouses, 551 (or 84%) are in the U.S. and Canada. Half of the company's recent warehouse openings have been in those relatively mature markets. However, Costco has also been successful in numerous international markets, from Europe to Latin America to East Asia. Long-term, Costco has the potential to double or triple its warehouse count through broader international expansion.
Foolish final thoughts
Even Costco bears have trouble finding much fault with the company's financial performance. It posts pretty consistent mid-high single digit revenue growth, and its operating margin has remained within a tight 2.5%-3% range for the last decade.
The best most bears can come up with is that Costco stock is a little pricey, as it trades for about 25 times current year earnings. However, long-term investors should be happy to pay that price, knowing that Costco is likely to continue posting above-market growth for decades to come. No matter what day it is, it's probably a great day to buy Costco stock.