Is It Time to Go Big-Time With Costco?

By Ryan Guenette - August 13, 2012 | Tickers: COST, DG, PSMT, TGT, WMT | 0 Comments

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The Costco craze has swept across the world. Costco’s unique business model of a subscription fee and immense packages of products have drawn customers, as they believe they are saving money in this tough economic environment. As of 2011, The United States, Canada, Mexico, United Kingdom, Japan, Taiwan, Korea, Puerto Rico, and Australia all have at least 3 Costco locations, with the total number of locations being 592. Since being founded in 1983, Costco Wholesale Corporation (NASDAQ: COST) has built its vast network of locations and distribution channels all over the world, and has expanded at accelerated rates even in the face of economic downturns. This has fueled Costco’s stock to make new all-time highs, nearly hitting $100 a share. Year to date, the company is outperforming the market, rising 14.46%. So is it time to go big-time with Costco before it is a triple-digit stock?

Underlying Business is Impenetrable

In 2009, Costco Wholesale Corporation reported earnings per share of $2.47. In 2014, the average analyst consensus projects Costco deriving $4.84 from its business. This immense gain represents 95.95% growth in Costco’s earnings per share over just 5 short years. Based on these statistics, Costco’s compound annual growth rate (CAGR) is 14.40%, a tremendous feat for a company that is already largely established. Costco’s growth can be described as consistent, as each and every year it is anticipated to earn more than it did the year before. Additionally, the company pays out an annual dividend of $1.12, which at current prices, puts the yield at 1.15%. This is up from last year’s annual dividend of $0.96, and is further expected to grow into the future. By 2014, the street projects Costco’s annual dividend reaching $1.28, which at current prices, would put Costco’s dividend as yielding 1.34%. These projections estimate 14.29% growth in the dividend in just two short years. While not huge, the dividend does add a layer of value to the company, as well as display management's dedication to providing lucrative returns to its investors.

The chart below displays Costco’s sales, operating profit, net income, net margin, operating margin, earnings per share, dividend, and rate of dividend (the percentage of net income that is paid out in the dividend) over the coming years.

The Costco Factor

Costco is unique and vastly different compared to other discount retail stores. To even get inside a Costco warehouse, consumers must buy a membership. The most basic membership costs $55.00, while the most advanced membership costs $110.00. This is where Costco earns the large majority of its revenue. Once inside a Costco warehouse, the member is exposed to huge quantities of product, that by buying in immense quantities, the consumer saves on a per unit basis. Additionally, since members have already paid money to be a member, they feel the overwhelming urge to buy more items, as the more items they buy, the more they save. Costco houses everything from printers to toilet paper, and prides itself as being a one-stop shop. In this division of Costco’s business, they barely break-even; as they pride themselves on not marking up items so much to as discourage a renewal of the membership at the end of the year, due to a lack of savings. This business model is highly different than Walmart’s or Target’s, yet has been highly successful. Despite this success, this business model does possess two main flaws. Firstly, not everyone wants to buy gigantic quantities of product, as it may go bad before they can utilize it. Additionally, the business model may be overly dependent on membership fees.

Is Costco An Industry Leader?

Compared to some of Costco’s most prominent competitors, such as: Target Corporation (NYSE: TGT), Wal-Mart Stores Incorporated (NYSE: WMT), PriceSmart Incorporated (NASDAQ: PSMT), and Dollar General Corporation (NYSE: DG), Costco compares relatively favorably.

In terms of growth, Costco is in the middle of the road, while Dollar General commands the industry. All companies in the industry pay out dividends, with Target having the largest and fastest growing dividend. In the fundamental ratio comparison, PriceSmart appears to be trading at a premium, while Target possesses the most attractive multiple. When growth is taken into account, Dollar General is the most attractive, while Costco appears a little expensive. In the net profit margin comparison, all companies possess lower margins, as they all try to balance savings for the consumer and profits for the shareholders.

The Foolish Bottom Line

Costco has already run up a tremendous amount, and is a handful of quarters away from all-time highs. The Costco craze has swept the world, and has kept Costco’s underlying business strong through difficult economic environments. Over the long term, Costco is an incredible opportunity, as they are just beginning their international expansion, yet at the current prices, Costco appears a little pricy. With a price/earnings ratio near 27, and a price/earnings/growth ratio around 1.70, I believe Costco may be a little inflated at the moment. Costco is a great company, with a tremendous underlying growth and a unique business model, but is a little overvalued. Wait for a sizeable pullback, and then add Costco to a portfolio focused on long-term growth.  

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