Costco Investment Thesis

Costco Investment Thesis: Costco customers are a rare breed – the sort that every retailer longs for. They are passionate about their memberships, and they can be counted upon to renew each year. Better still, they consistently increase the size of their baskets as Costco expands its list of products. 

Gluten-free snacks? Costco has them. Rotisserie chicken? It has those, too. But beyond that, Costco has everything from pianos to engagement rings to caskets. Many Costco members are of the opinion that if Costco doesn’t sell it, they don’t need it. 

That’s the sort of news investors like to hear, but does it translate into profits for shareholders? After all, Costco is also known for its high minimum wage – $16 per hour – and Costco’s hourly employees average $24 per hour. That extra pay adds up, and some investors worry about the impact on Costco’s bottom line. 

Analysts have looked at Costco from every angle, and their results are consistently positive. The Costco investment thesis is persuasive – here’s what makes Costco stock a buy. 

Costco Market Share Is Second To Sam’s Club

Costco is a warehouse-style retailer that offers products in a wide variety of categories. The biggest lines include groceries, electronics, health and beauty, apparel, appliances, gas, and pharmacy services, though other types of items get shelf and floor space from time to time. 

The difference between Costco and other retailers that operate in any of these categories is that Costco offers a limited selection within product types. Instead of a shelf with 50 brands of shampoo, Costco has just a handful – and packages are large for bulk-buying. 

That’s how Costco keeps prices low. It buys massive quantities of a limited number of each product at a discount, then passes a large part of that discount onto consumers. The company requires a membership to shop in its stores. The fees it collects contribute to top line revenues and bottom line results. 

Apples-to-apples comparisons are difficult to make, because there aren’t many warehouse stores that offer the same collection of product categories. Generally speaking, the following retailers are considered Costco’s direct competitors: 

• BJ’s Wholesale Club
• Office Depot
• Aldi UK
• Sam’s Club
• Lowe’s
• Kroger
• The Home Depot
• Amazon
• Target
• Walmart
• Best Buy

However, for the purposes of measuring market share among brick-and-mortar warehouse or superstores, only one competitor really matters. Walmart and its Sam’s Club warehouse stores have a value proposition that is similar to Costco’s, and they pursue the same customers. 

Between the two, Walmart has an overwhelming lead with more than 70 percent of market share. Costco is closer to 17 percent. With that said, it is worth noting that others in this space barely register. Target (TGT) has less than 4 percent of market share, and BJs Wholesale Club comes in around 2.5 percent. 

Does Costco Stock Have A Moat?

Analysts consider Costco a wide-moat stock for several reasons, but two in particular stand out. These are the two protecting Costco from losing market share to other warehouse retailers like Walmart/Sam’s Club, as well as preventing encroachment from e-commerce giants like Amazon. 

First, the company is well-established with a massive presence in the marketplace, so it doesn’t have to make a profit on retail sales.

In fact, most products carry no profit margin at all for the company – an edge that is virtually impossible for competitors to match.

Instead, Costco makes its money from membership fees – and that’s where customer loyalty becomes so valuable. With the same customers renewing memberships year after year – and new ones coming on board – industry experts are convinced that Costco’s success will be difficult for competitors to duplicate. 

Second, Costco’s brand is exceptionally valuable – and that is something that newcomers to the field cannot buy or promote their way into. Costco built its brand over decades, and in 2020, Forbes ranked it 79th on the World’s Most Valuable Brands list. 

Some of that brand awareness and loyalty is directly related to Costco’s above-average compensation strategy. Costco can attract and retain the best hourly workers in the industry, thanks to its reputation as an employer-of-choice.

In 2021, Costco came in 4th on Forbes’ America’s Best Employers list, and it was 13th on Forbes’ Canada’s Best Employers List. Costco achieved 20th place on the World’s Best Employers List for 2020. 

Is Costco Growing Revenues?

Costco has been growing revenues for some time, and that didn’t slow during the market ups and downs caused by COVID-19.

In fact, Costco didn’t really feel the economic pain of the pandemic, because consumers still needed the sorts of necessities that Costco carries. 

Revenues for the past five years are as follows: 

• Fiscal 2020 – net sales $163 billion/membership fees $3.5 billion
• Fiscal 2019 – net sales $149 billion/membership fees $3.3 billion
• Fiscal 2018 – net sales $138 billion/membership fees $3.1 billion
• Fiscal 2017 – net sales $126 billion/membership fees $2.8 billion
• Fiscal 2016 – net sales $116 billion/membership fees $2.6 billion

Consistent growth in Costco’s revenues – in conjunction with an expanding footprint and increased same-store sales year-over-year – puts Costco stock at the top of many investors’ buy lists. 

What Rate Are Costco Earnings Growing?

The fact that Costco is able to grow revenues is promising, but the real question is whether the company can turn those revenues into shareholder earnings.

In this case, the answer is a firm, unequivocal yes. Costco is growing earnings at a steady clip. The last five years have delivered the following results: 

• Fiscal 2020 – Net Income $4 billion
• Fiscal 2019 – Net Income $3.7 billion
• Fiscal 2018 – Net Income $3.1 billion
• Fiscal 2017 – Net Income $2.7 billion
• Fiscal 2016 – Net Income $2.4 billion

Take a close look at these numbers as compared to the revenue from membership fees. The near-match demonstrates that Costco’s results are more about customer loyalty than its pricing strategy. 

Costco’s net income translated into the following earnings per share: 

• Fiscal 2020 – earnings per share $9.02
• Fiscal 2019 – earnings per share $8.26
• Fiscal 2018 – earnings per share $7.09
• Fiscal 2017 – earnings per share $6.08
• Fiscal 2016 – earnings per share $5.33

The consistent revenue growth paired with increasing income and earnings makes Costco a strong buy for most investors. 

Costco Management Quality Gets An A+

The Costco C-Suite is home to long-tenured leaders who have proven their ability to achieve success year after year.

In particular, President and Chief Executive Officer W. Craig Jelinek Jelinek has served as an officer since 1995, and he rose to his current position in January of 2012.

Jelinek has developed a reputation as a kind, humble leader who puts employees first. That strategy, above all else, is thought to have created customer loyalty through strong employee engagement. 

Competition Challenges A Hurdle For Costco

Competition from established retailers – especially e-commerce retailers – is the biggest challenge the company faces.

It has a reasonably successful online channel already, but that will grow in importance as web-based sales continue to trend upward. 

While critical, e-commerce isn’t the most immediate concern. Many analysts expect Costco will be unable to grow comparable sales in the coming 12-months after the boom during the height of the COVID-19 pandemic.

If comparable sales remain flat or decrease a bit, there could be a negative impact on the company’s financials. Fortunately, none of that is expected to disrupt returns from Costco stock long-term. 

Costco Investment Thesis Conclusion

When it comes to the Costco investment thesis, the bottom line is this: Costco stock is not without risk, but it has far more going for it than against it. 

The company has a carefully considered strategy, the business is growing, and competitors will have a difficult time catching up.

Specifically, Costco has a solid history of increasing revenues and earnings, and it carries the sorts of consumer staples that are in-demand – no matter what the market and larger economy are doing. Combined, those elements make Costco stock a smart buy. 

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.