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Costco Stock Is Built to Stay Competitive over the Long Haul

Tom Taulli

Costco (NASDAQ:COST) has been a prime example of consistent growth. And this has certainly been reflected in the stock price. During the past 15 years, Costco stock has averaged a compound annual return of nearly 14%. This means that an initial $10,000 investment would have turned into nearly $72,000!

To put all this in perspective, Walmart (NYSE:WMT) posted a 4.62% return and Target (NYSE:TGT) gained 6.26 during the same period of time.

Yet there are some nagging issues with Costco stock. First of all, the valuation is far from cheap. Consider that the price-to-earnings ratio is 30X. And, even on a forward basis, the multiple is still a hefty 27X.

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Costco also has a fairly meager dividend yield, which is at 1%.

But these factors may pale in comparison to other risk-factors.  For example, the company has increased its starting hourly wages by $1 to $14.50. As for existing workers, there was an increase in the rate by a range of 25 cents to 50 cents an hours. Note that Costco has an employee base of 130,000 in the U.S. alone.

Yet there are other pressures on margins. Let’s face it, the retail market continues to be fiercely competitive, especially as lower tier players reduce prices to gain marketshare.

It also does not help that Amazon (NASDAQ:AMZN) owns Whole Foods and has been leveraging this platform with its extensive digital assets.

Now for the Good News on Costco Stock

Even with the challenges, Costco has still been able to manage through them. It’s a testament to the outstanding management team.

During the latest quarter, net sales jumped by 12.1% to $31.62 billion and same-store sales rose by an impressive 7%, excluding gas and currency swings. Costco also remains highly profitable, with net income rising from $700 million to $750 million.

If anything, Costco appears to be the rare traditional retailer that should avoid much of the impact from Amazon. The key is that the company has a stellar business model.

The warehouse format means that the company can sell higher volumes, provide lower pricing and benefit from lower maintenance expenses.

And of course, the membership fee provides a nice source of recurring revenues. During the latest quarter, the base grew by about 500,000 to 50.4 million.

The renewal rate was also 90% in the U.S. Keep in mind that last year the company raised its membership fees. In other words, the base is quite loyal.

Another key for Costco stock is that the company has been getting traction with its digital efforts. During the most recent quarter, revenues from e-commerce jumped by nearly 37% (the company operates sites in the U.S., Canada, UK, Mexico, Korea and Taiwan). Costco has also been investing heavily in same-day delivery, such as with a partnership with Instacart.

According to the latest earnings call, the CFO noted that e-commerce actually gets more people to the brick-and-mortar stores. And this often means even more purchases.

Bottom Line on Costco Stock

Going forward, there is likely to be continued pressure on margins (although, the tax reform bill should help alleviate some of this). But then again, this is the reality for most retailers, as there is a need to rethink the business – especially with digital investments.

But the good news for Costco stock is that the company is well positioned for this new world. Most importantly, there are few signs of a slowdown in the growth rate.

So while the valuation on Costco stock is a bit pricey, a premium is well deserved.

Tom Taulli is the author of High-Profit IPO StrategiesAll About Commodities and All About Short SellingFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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