What’s better than investing in companies that provide products that people need?
Think about it.
People have to have products like soap, toothpaste, and clothing. Just can’t live without this stuff.
What about food? We have to eat, right?
What if this company also provides all the food you can possibly eat?
Well, one would assume that this would probably be a pretty good investment.
[ad#Google Adsense 336×280-IA]And if the last ten years of performance (both at the company level and its stock) are any indication, you’d be right.
Take a look at Costco Wholesale Corporation (COST).
This is an extremely successful membership warehouse company.
They operate 663 warehouses worldwide, with a concentration on North America.
And these warehouses are huge – typically 144,000 square feet.
But they differentiate themselves in a few key ways.
First, they have a membership program. This allows them to profit not only from the sale of retail goods, but also through the membership fees. These fees actually make up the bulk of Costco’s profit.
Second, they offer bulk merchandise. This saves consumers money by allowing them to buy items at scale.
Third, they offer their workers a higher rate of pay than most competitors. This imbues their workforce with a sense of pride and loyalty, which perhaps rubs off on their customers as well.
There’s no doubt the system is working for them, as we’ll see below.
Revenue was $52.935 billion in fiscal year 2005. That grew to $112.640 billion in fiscal year 2014. So revenue more than doubled in 10 years from an already large base. This company is now taking in more than $100 billion per year! That growth represents a compound annual growth rate of 8.75%. Not too shabby for a huge company.
Let’s take a look at how that revenue boiled down to profit.
Earnings per share increased from $2.18 to $4.65 during this time frame, which is a CAGR of 8.78%. Very similar to what the top line grew at, which is, again, very solid.
S&P Capital IQ is calling for EPS to compound at a 12% annual rate for the next three years, citing increased market share and improving margins.
Costco may not have the multi-decade record of increasing dividends that some other companies have, but what they lack in length they make up for in growth.
COST is featured as a “Contender” on David Fish’s Dividend Champions, Contenders, and Challengers list. That’s a document that has compiled all 589 US-listed stocks that have increased their dividends for at least the last five consecutive years. Costco earned this designation by handing out dividend raises for 11 consecutive years now.
But even better, the five-year dividend growth rate stands at 14%.
The stock currently yields just 0.99% right now. However, a low payout ratio of just 29.5% means there’s plenty of room left in the tank for continued dividend raises.
So you have a dividend that is growing at a rather rapid rate here, and a low payout ratio means it will likely continue growing as such for years to come.
One aspect of a company that I always enjoy seeing is a conservatively run balance sheet.
This tells me that management is concerned about shareholders’ money and is responsible with such.
A lack of debt also means a company is flexible, should opportunities arise.
The long-term debt/equity ratio is 0.41, which is fairly conservative.
And the interest coverage ratio – a measure of interest expenses against earnings before interest and taxes – is excellent, at 29.3.
Retailers are plagued with one problem: low margins. COST is unfortunately no different. Net margin has averaged 1.76% over the last five years. But they’ve done well in spite of this low margin, due to their membership program. Return on equity, which is another measure of profitability, has averaged a fairly robust 14.94% over this period.
I mentioned earlier how successful Costo has been. You can see that not only in the fundamentals, but also the stock performance – the stock is up over 200% over the last decade. That trounces the S&P 500 index over the same period.
Costco’s differentiation has allowed them to grow at a healthy rate, and has put them in a leading retail position. Their low margin isn’t uncommon in retail, but it’s actually the membership program that accounts for most of their profit. This puts them in a great position. Because the fees account for most of their profit, they can afford to squeeze pricing down to the bare minimum. This allows them to compete at an almost unparalleled level, especially when you combine that type of aggressive pricing with bulk scale.
Even while the company continues to hike the membership fees, membership renewal rates remain stable in the high 80% range. This bodes well for the company, as it means the customers remain sticky and loyal.
There are risks, however. The retail environment is extremely competitive, and price wars are not uncommon. Furthermore, the retail landscape is changing, as consumers increasingly shop online. This could mean that running large warehouses may be less profitable at some point in the future.
I’m not a shareholder in Costco yet, but I would like to invest in the company if the right price happens to come along.
This is a great retail company. As such, its shares have been in demand. The P/E ratio is 29.78 right now, which is high even for a company that typically sports an aggressive valuation. Compare that current ratio to COST’s five-year average of 24.5.
I valued shares using a two-stage dividend discount model with a 10% discount rate and a 14% growth rate for years 1-10, along with an 8% terminal rate. The short-term growth rate is in line with Costo’s dividend growth rate over the last decade, while the long-term growth rate is in line with COST’s earnings growth rate. The DDM analysis gives me a fair value of $126.97.
Bottom line: Costco Wholesale Corporation (COST) is a great retailer. They’ve been able to differentiate themselves through a membership program, cutthroat pricing, bulk offerings, and a sense of loyalty both among customers and its workforce. This has led to an enormous amount of growth for the company as well as an excellent performance from the stock. It’s a dominant warehouse retailer and I see nothing that will stop this company from continuing to grow. They’re incredibly well-placed with numerous competitive advantages. It’s not the cheapest stock around right now, but I’d consider COST on pullbacks.
— Jason Fieber, Dividend Mantra
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