Should I Buy Costco? 3 Pros, 3 Cons

by Tom Taulli | October 10, 2012 1:22 pm

Costco (NASDAQ:COST[1]) has been a great deal for shareholders in 2012. So far, the return is a juicy 25%.

The company has been growing at a nice clip, as seen in the latest quarterly results released this morning. Earnings climbed by 27% to $609 million, or $1.39 a share, and revenues rose by 14% to $32.22 billion. The Wall Street consensus was for earnings of $1.31 a share and revenues of $31.69 billion.

So can Costco keep up the momentum? Or is it time for shareholders to lighten up? To decide, let’s take a look at the pros and cons:

Pros

Powerful Business: Costco charges an annual membership fee, which provides a lucrative source of recurring source of revenue. The company also sells food and gas as loss leaders, which leads to a lot of daily foot traffic. Oh, and the company’s wide geographic footprint means less need for inventory storage systems.  All in all, it’s a business model that leads to strong growth with low costs.

Merchandise: Costco continues to be innovative with its product selection. Of course, the company has a wide assortment of top brands like Green Mountain’s (NASDAQ:GMCR)[2] K-cups, Garmin’s (NASDAQ:GRMN[3]) GPS devices and Dyson appliances. Costco also sells fine wine and even diamonds.

Market Size: Costco still has lots of room for growth, even in the U.S. In fiscal 2012, it launched 10 new warehouses and the company plans to add 15 more next year.

But Costco is also in the nascent stages for global markets. For example, the company has been expanding in Canada, Japan, Korea and Taiwan. So far, it looks like Costco’s membership model is resonating in these countries.

Cons

Macroeconomic Headwinds: Unfortunately, economic growth in the U.S. has remained sluggish. And with the expected cutbacks in federal spending and lower imports from Europe and Asia, there may even be a recession in 2013. Costco could feel some pressure on sales as a result.

Competition: Costco must deal with tough rivals like Target (NYSE:TGT[4]) and Walmart (NYSE:WMT[5]). But there is also pressure from the dollar stores, such as Family Dollar (NYSE:FDO[6]), Dollar General (NYSE:DG[7]) and Dollar Tree (NASDAQ:DLTR[8]). Even e-commerce operators such as Amazon.com (Nasdaq:AMZN[9]) are a factor.

Cost pressures: Costco’s low-cost model could come under pressure. The drought has resulted in hikes in corn and soybean prices. There may also be some pressure from gas prices, especially in California.

Verdict

It’s actually tough to find much wrong with Costco. The company has a powerful business model and lots of growth potential. It continues to find ways to keep costs low.

On the other hand, the valuation is far from cheap, with the price-to-earnings ratio at 29. The dividend is also only 1.10%, so it’s not likely to get much attention from income-seekers. But great companies usually sell at a premium.

Putting it all together, the advantages are too big to ignore — the pros outweigh the cons on Costco’s stock for now.

Tom Taulli runs the InvestorPlace blog IPOPlaybook[10], a site dedicated to the hottest news and rumors about initial public offerings. He is also the author of “How to Create the Next Facebook.[11]”  Follow him on Twitter at @ttaulli[12]. As of this writing, he did not hold a position in any of the aforementioned securities.

Endnotes:
  1. COST: http://studio-5.financialcontent.com/investplace/quote?Symbol=COST
  2. GMCR): http://studio-5.financialcontent.com/investplace/quote?Symbol=GMCR)
  3. GRMN: http://studio-5.financialcontent.com/investplace/quote?Symbol=GRMN
  4. TGT: http://studio-5.financialcontent.com/investplace/quote?Symbol=TGT
  5. WMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=WMT
  6. FDO: http://studio-5.financialcontent.com/investplace/quote?Symbol=FDO
  7. DG: http://studio-5.financialcontent.com/investplace/quote?Symbol=DG
  8. DLTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=DLTR
  9. AMZN: http://studio-5.financialcontent.com/investplace/quote?Symbol=AMZN
  10. IPOPlaybook: http://investorplace.com/ipo-playbook/
  11. How to Create the Next Facebook.: http://www.amazon.com/gp/product/1430246472/ref=s9_simh_gw_p14_d0_i1?pf_rd_m=ATVPDKIKX0DER&pf_rd_s=center-3&pf_rd_r=0GRB6ZMCTYDZVNG7Q7NV&pf_rd_t=101&pf_rd_p=470938811&pf_rd_i=507846
  12. @ttaulli: https://twitter.com/ttaulli

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