How does Costco make money? Is it a great company?

Costco

Please read the first the article I wrote a few days ago about Costco, “Costco has been disrupting retail industry“.

Costco
Credit: AmCham Taiwan

eCommerce

The e-commerce net sales generated by Costco’s e-commerce division accounted for approximately 6% of the company’s net sales in 2020, which has doubled from 3% in 2015. At the peak time of the pandemic in 2020, the second to fourth quarter, Costco’s e-commerce department had an amazing annual growth rate of 75% to 101%.

But this figure also shows that Costco’s customer base is mainly made up of shoppers in person.

Customers first

Every company will put the phrase “customer-oriented” on the lips and write it in the annual report submitted to the Securities Regulatory Commission. However, there are very few companies that can be implemented and can be clearly felt by customers, and Costco is definitely one of them.

All consumers must join the membership and pay the annual fee for shopping; and the annual fee from the membership accounts for 2/3 of the company’s revenue. Without the annual fee of the member, the company will immediately lose money. This unique business model is actually rare in the business world, but Costco has been very successful.

Costco has even restricted the gross profit margin of the products sold to be below 13%. Wal-Mart in the same industry (ticker: WMT) is 24%, and Target (ticker: TGT) is 29%.

Efficieny take first priority

The entire Costco company believes in the no-frills policy, focusing on bringing value to customers. On average, only 3,700 ∼ 4,000 products will be sold, while Wal-Mart has 120,000 ∼ 140,000 products, and Amazon has as many as 600 million items sold. Costco first screens customers for unnecessary or poorly-selling products, so that similar products will almost only leave the best-selling items.

Fewer items have many advantages: less supplier management, easy arrangement of store displays, larger discounts when negotiating prices with suppliers, reducing the speed of customer purchase decisions and increasing purchase willingness, and improving inventory turnover rate.

Please note that Costco’s original name is Costco Warehouse, because it directly puts the entire package of goods purchased by the supplier on the shelves, and its store is a warehouse with air-conditioning and checkout counters, which can save storage costs. You don’t have to worry about the layout of the store, unpacking, and sub-packaging when entering and shipping; and it can stimulate sales.

Valuation

Costco has proved that it is one of the few retailers that can resist Amazon. Just look at the following valuation table:

CostcoAmazonWalmart
Stock price549.733,580.41146.54
Market capital (in US$ billion)242.8841,816408.627
Past 1 year stock performance41.54%12.05%-3.34%
Past 5 year stock performance 261.65%383.62%106.74%
P/S1.244.020.72
P/E48.7870.0751.6
Dividend yield0.57%01.5%

Please pay special attention to its price-to-earnings ratio, which is no worse than Amazon. Amazon is classified as a technology stock in Wall Street, and there is an oligo-profitable AWS cloud division. However, Costco is not a technology company, and even the e-commerce department is much worse than Amazon, and there is no cash cow like the cloud department.

It is a very traditional physical retail trade. It can have a higher price-to-earnings ratio than most technology companies, and other valuations; you can see how popular it is among investors. If I cover up the company name in the above table, everyone must think that this is the hot newly listed SaaS company. You may say that it is similar to Walmart, but please take a look at the stock price performance of the past one and five years!

How is the business performance?

PerformanceAnnual growth
FY 2021 net revenue (US$ billion)192.056+18%
FY 2021 member revenue (US$ billion) 3.877+9%
FY 2021 net income (US$ billion) 5.007+25%
FY 2021 gross margin11.13%+7bps
FY 2021 carholders (million) 111.6+5.78%
FY 2021 warehouse worldwide 815+2.516%

Investors rewarding

Dividends

Quarterly dividends

Costco’c current dividend yield close to 0.8%. It looks not quite amazing. However, Costco grows its yearly dividend by more than 277% in the past 10 years, which is quite a feat.

Special dividends

Costco is a rare case, in addition to distribute dividends quarterly, it will also issue additional large cash dividends from time to time. Over the last 10 years, Costco issued four special dividends. In the 2021 fiscal year, two special dividends have been issued:

  • Ten dollars per share (December 2020)
  • Ten dollars per share (April 2021)

Repurchase

In terms of stock repurchase, Costco did not fall behind. In fiscal year 2021, it repurchased 318,000 shares, which is equivalent to 0.0072% of the outstanding shares.

Munger and Costco

Talking about Costco reminds me of Chrlie Monger, a famous shareholder of this company. It has been a member of the board of directors since 1997. There are only three stocks in his personal portfolio, and Costco is one of them. Munger does not conceal his preference for Costco, and has repeatedly publicly recommended investors to buy more Costco stocks.

He also has a famous saying, “Good stocks are not cheap.” In fact, he refers to Costco. The financial media really went to investigate whetherhe was consistent with his words and deeds, and found that he would continue to buy small amounts to increase the stocks of Costco. As of the end of 2020, he personally owns 186,000 shares of Costco.

Munger once said that Costco has a unique element that Amazon doesn’t have–the company culture. “It’s quite important,” Munger said in response to a later inquiry over the importance of evaluating a company’s culture in making investment decisions.

“Part of the success of a company like Costco — and it’s been amazing that one little company, starting up not all that many decades ago could become as big as Costco did as fast as Costco did. And part of the reason for that was cultural. They have created a strong culture of fanaticism about cost and quality and so forth, and efficiency and honor, all the good things. And of course, it’s all worked. And so, of course culture is very important.”

Lei Jun’s comments on Costco

Xiaomi (Xiaomi, Hong Kong stock code: 1810) founder Lei Jun once commented on Costco with emotion on a forum: “Credit card revenue accounts for 1/3 of total profits, and nearly 70% of operating profits come from membership fees, the gross profit margin is only 6.5%.” And he admitted that he has benefited a lot from the company’s business philosophy. In fact, among the well-known entrepreneurs in China, not only Lei Jun, but also many people admitted that they have studied Costco and applied it to their own enterprises, and expressed their admiration for Costco’s strong competitiveness and customer loyalty .

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2 thoughts on “How does Costco make money? Is it a great company?”

    1. David, Costco is a great company with no doubt. However, the valuation is just crazy, evern higher than many top technology companies. If you have been tracking Costco stock price, it did not fall during year 2020 market crash, and earn resist in recent market correction as well. I mean it’s very resilient to market downturn.

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