One Perfect Long-Term Stock...And the Secret Behind its Success

By Michael Nolan - August 7, 2012 | Tickers: COST, LUV, TGT, WMT | 0 Comments

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Costco. Normally, I like to build suspense about the stock I'm sharing with you, but, today, I'm coming right out with it: Costco (NASDAQ: COST) is a perfect long-term stock. But you shouldn't trust just anyone who tells you what to invest in: you should have evidence; you should have proof. 

So, what's the secret behind Costco? Well, you already know its keys to success: wholesale prices, seemingly unlimited amount of products, etc. But what is the key behind the scenes that differs Costco from its competitors?

Well, what fun would we have if I gave everything away immediately. I mean, come on, I already gave you the ticker. I can't just hand over everything.

So before I get to Costco's secret, why don't I start with the long-term case for Costco.

Costco: Profile of a Company

Several elements of the goliath make Costco into the successful company that it is: the wholesale factor I mentioned earlier, the low-cost/high-profit element, in addition to a few other parts of the discount store. Yet, many successful companies are publicly traded. Success isn't enough to make me click "buy" for the long run. So what makes Costco perfect for years to come?

Check out Costco's Return on Equity (ROE): according to theory, the company with the highest ROE (in comparison to its competitors) typically brings the best returns to its shareholders. Costco's ROE is 12.50 -- a very competitive ROE. Rival SuperValu's ROE is negative ... not very impressive. 

Now, how about their dividend? Well, a 1.1% dividend isn't whopping, but it is something. 

And, finally, check out their most recent year.

Not bad, huh? Costco is right at their 52-week high, which doesn't always mean good things. Similar to how cells have a "Hayflick limit" creating an arbitrary maximum point of growth, so do many stocks. However, Costco does not appear to be slowing down any time soon. Expect Costco's 52-week high to only keep getting higher, one reason it's a sure buy as a long-term option.

The Moment of Truth

So, finally, what is the secret behind a large part of Costco's success? To put it simply, the employees. I know that going to Costco isn't all about spending time with the checkout workers, but give me a chance for a second. Costco in the wholesale business is essentially comparable to Southwest (NYSE: LUV) in the airline business in terms of employee happiness -- and, more importantly, how noticeable it is to customers. And just look at how well it has worked for Southwest.

The key to their happiness is the way they are treated. The CEO of Costco, Mr. W. Craig Jelinek, is the best in the business. He pays nearly all of his workers, even the ones cooking hot dogs, at least $20 per hour. Nearly three times minimum wage for a job that beckons to be paid at a fairly low level. 

Secondly, over 90% of all employees receive complimentary health care from Costco. Checkout workers, salesmen, customer service representatives -- you got it. Nearly everyone gets free health care from Costco. So, why is this important? Well, go to your local Costco, and next time you're there, ask them. Ask an employee how they like their job. I know you may think it's silly but right when I walked into my Costco last week, I turned to the one-hour photo desk right inside the door and asked the gentleman developing the photos how he liked working for Costco. He smiled and said he absolutely loved it. I asked him if he was receiving complimentary health care and he confirmed that he was, and he even wasn't shy sharing that he was paid about $40 per hour -- a pretty outstanding wage for someone who develops photos. 

These types of things are easily overlooked but are absolutely critical to the performance of a company. In a recent interview, Mr. Jelinek noted that he once worked as an unskilled worker when he was a teenager for 75 cents per hour. He thought it was criminal and promised that he would never treat anyone that way in his life. And he sure is staying true to his promise. In fact, a survey by CareerBliss, which surveyed over 100,000 retail workers, found that Costco had both the highest employee happiness rate, as well as the highest average salaries. Competitor Wal-Mart (NYSE: WMT), one of the biggest threats to Costco's success, wasn't in the top ten in either category: one reason I'm keeping Wal-Mart out of my long-term portfolio (along with the fact that Costco keeps about 20% of the amount of inventory that Wal-Mart does because they only keep high-quality merchandise, which saves them money). Furthermore, Costco employees make, on average, 64% more each year than rival Sam's Club employees do. Figures like this are why Costco has one of the highest employee retention percentages in the nation -- in any field (3M was a close second -- another great long-term stock. But, that's for a later report.)

Speaking of competition, one Costco competitor seems to have a slight advantage...to the naked eye. But you don't have a naked eye, no. You have a very Foolish eye, wise from reading Foolish article after Foolish article. So, details like competitor Target's (NYSE: TGT) shorter lines and better hours don't even play a part in the grand scheme of things -- Target's customer service is just as mediocre as the rest, and that stands above all.

This philosophy all started with former CEO Jim Sinegal, who believed strongly in making his employees happy. In fact, he was famous for walking around the floor of the nearest Costco in a clerk's uniform and a name tag that just said, "Jim," making it easy for customers to assume him to be a clerk. He was so intent on this style of management that he even admitted that, "Wall Street is in the business of making money between now and next Tuesday. We're in the business of building an organization, an institution that we hope will be here 50 years from now. And paying good wages and keeping your people working with you is very good business." This mentality built the company to where it currently stands now as the third largest retailer in the country.

The Foolish Bottom Line

Costco certainly seems to have what it takes the go the distance in your portfolio, according to our few metrics and employee satisfaction ratings. Yet, no portfolio should be built around any one stock. For more stocks to keep until retirement, check out my latest post, 5 Stocks to Keep for the Rest of Your Life. And for more current information on stocks to buy or stay away from right now, check out One Stock to Buy Right Now and How Apple's Acquisition of AuthenTec Will Affect Your Portfolio...And Your Next Phone.

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