So here I am, just catching up on some research on companies I own, when I come across a dazzling piece of analysis on Costco (NASDAQ:COST) by Goldman Sachs (NYSE:GS) retail analyst Adrienne Shapira.
Now, when I say "dazzling," what I really mean is "unfathomably banal." Maybe I should be more direct.
As most any investor with a pulse knows, we here at The Motley Fool don't exactly put much faith in Wall Street research. That's mostly because we believe that this research benefits the banks rather than the retail investors to whom the recommendations are supposed to be targeted. We've also found that Wall Street tends to miss the forest for all the trees, obsessing over short-term performance at the expense of the longer term.
That is not to say, though, that we find all Wall Street research to be without intrinsic merit. Many analysts are extremely knowledgeable and thorough in gathering and interpreting data from the companies they cover.
A sterling counterexample is Shapira's May 26 report on Costco, a selection of Motley Fool's Stock Advisor newsletter. Shapira called the company "fully valued," based, among other things, on its "unfocused capital mgmt." I'm not changing that last word -- for some bizarre reason, the word "management" is abbreviated as "mgmt" in the report, mid-sentence.
MEDIC!
Shapira's prescriptive here is pretty simple. Costco has more than $4 billion cash on its balance sheet, and it also has a standing authorization from shareholders to repurchase more than $500 million of its own shares. Shapira says, "We believe that investors would view stock repurchase as an effective use of capital in a time of low unit growth, and feel a meaningful buyback program would be a positive to the stock."
Come again? Does anybody else see the problem here? In one breath, Shapira calls the stock fully valued, and then in the next she declares that management should heed investor sentiment and buy back shares. Here's my question: Why in the name of all things named after John F. Kennedy would it be constructive for a company to use its cash to buy back fully valued shares? Even if Costco has fallow capital, how could one possibly argue that overpaying for its own equity would be a good use? This makes no sense.
Now, on one level I do agree -- Costco ought to find the most efficient use of its capital. There are plenty of things it could do with excess capital, including raising the dividend, or announcing a special dividend, if management is concerned that a higher dividend isn't sustainable. The time for management to buy back company stock is when it thinks that stock is undervalued, not when it's got a beelyun or two burning a hole in its pocket. That's insane. If Costco executives think their company's stock is undervalued (as I do), they should repurchase. If they have a better use or believe that the stock is no bargain, then they would be crazy to do something because some cockeyed analyst thinks that the market would look kindly upon it.
Yes, Costco should not hoard cash if it has nothing better to do with it. But I don't consider doing something stupid with the cash to be better than holding on to it. If Shapira believes the stock is fully valued, then by calling for a buyback, she is advocating that Costco do something stupid.
It's like that old exhortation, updated for Wall Street: "Don't just sit there! Do something stupid!"
Fortunately, a look back over time shows that Costco's record of deploying its liquid assets is nearly unassailable. Given that its warehouses are generally funded by operating cash flows, and given that each one tends to pay for itself after five years, if the company had opportunities to build more aggressively, rest assured it would do just that. Shapira, on the other hand, lowered her rating on Costco to a "hold" in December 2002, which turned out to be the lowest point for the company's shares in the past six years, and has not budged since. One would think that at some point the contrasts in track records would encourage Shapira to defer judgment.
Wesco Financial (AMEX:WSC) and Berkshire Hathaway's (NYSE:BRKa) (NYSE:BRKb) Charlie Munger had this to say about Costco at the 1999 Berkshire Hathaway annual meeting: "I'm such an admirer of the Costco culture and the Costco system that I'm not sure I'm totally rational. I love the place. That isn't so bad in life, to find a couple of things you love."
Fortunately, Costco's culture, as Munger refers to it, means that its executives tend not to pay too much for anything, ever. If Costco's execs decide to buy back stock (and I, for one, would welcome it), investors can rest assured it's because they believe it is priced at bargain levels.
See also:
- "Costco's Warehousing Money" by Bill Mann ...
- ... and evidence that Costco's even too complicated for the financial media in "That Confounding Costco"
Bill Mann is the guest analyst for the Motley Fool Hidden Gems newsletter. Looking for some small-cap stock ideas? A free30-day trialto read Bill's and Tom Gardner's analysis is just a click away.
Bill owns shares of Costco and Berkshire Hathaway. The Motley Fool has a disclosure policy.
