Warren Buffett sure likes to pick winners, and Costco Wholesale Corporation (NASDAQ:COST) has done nothing but win since its inception. Investors who bought COST stock in the summer of 2012 and held until now would be sitting with an almost-70% return.
COST has carved out a valuable niche as a purveyor of bulk goods at value prices to consumers looking to stock up. The warehouse store chain has continued to reap higher profits and return significant value to shareholders while maintaining rock-bottom prices and a cost leadership strategy which has put many other retailers out of business.
Warren Buffett has famously incorporated a number of investment strategies and intricacies to his investment style over time, adding to his original Graham-Dodd philosophical investment tool kit over time. Still a value investor, Warren Buffett has increasingly moved toward other qualitative metrics to supplement his quantitative analysis, incorporating things such as brand value, customer loyalty, and competitive advantage into his overall calculations for a given company.
For COST, the concept of a “moat” or a competitive advantage which can shield the big box retailer from competition and allow the company to earn outsize returns over a long period of time is one of the main reasons Buffett has chosen COST stock as one of his holdings and held this company for so long.
While the retail industry has been under attack of late from the very real threat that e-commerce poses to traditional bricks-and-mortar retailers such as Costco, I would argue that COST is far better positioned to handle the entrance of Amazon.com, Inc. (NASDAQ:AMZN) into the retail arena than many of its competitors, given the company’s size, scale, unique product offering, brand and customer loyalty in addition to its cost strategy, which has positioned the business as an extremely low-cost retailer, a segment few companies can survive in let alone provide shareholders with the same sort of value COST has over the years.
Many analysts have spoken at length about Costco’s ability to revolutionize food retail toward “bulk value” buying, a segment which did not exist in its current form until the warehouse retailer created it.
Using a strategy of having warehouse racking, rock-bottom overhead costs (but terrible customer service) and unique bulk-sized packaging, COST has been able to provide consistently lower prices than its competitors along with a unique product offering (many suppliers supply COST with a type of product or a specific package size that can only be found at COST), which increases customer loyalty and average order value simultaneously.
Looking at the Numbers
When looking at a company such as COST, with its very thin margins and a volume-based model, it is important to take a deep dive into the business’ fundamentals to grasp how the company makes money, and assess whether the it is likely to be able to continue to make money in the long-run.
Over the past 10 years, COST stock has performed exceptionally well — up 156% — as management executed on its cost-leadership strategy, driving top-line revenue growth while delivering increasingly higher rates of return on equity and invested capital.
During the decade, revenue grew 6.7% on a CAGR basis, with earnings increasing at a CAGR of 8.9%. Free cash flow more than tripled and both ROE and ROIC improved significantly as well. In the same time, COST’s ROE increased from just over 12% to a few points shy of 24%, and the company’s ROIC rose to 17.0% from 10.1%.
Bottom Line on COST Stock
The snowball effect of having millions of delighted customers pledge their loyalty to any given business is the kind of moat cherished by the kind of shareholders that Warren Buffett dreams about.
For investors looking for a retailer stock that will be most likely to snap back from declines in the wake of Amazon’s Whole Foods Market, Inc. (NASDAQ:WFM) deal news should consider COST stock. Its unique operating niche and its Buffett-friendly moat will likely reward investors plenty.
As of this writing, Chris MacDonald did not hold a position in any of the aforementioned securities.
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