The retail sector has been a tricky place to put your money over the past few years, but there are some solid picks that have been able to consistently deliver even in the face of a difficult industry environment. Warehouse retailer Costco (NASDAQ:COST) is one such investment whose solid business model has kept it above the fray as its peers battled against online competitors like Amazon (NASDAQ:AMZN). Costco stock has been a reliable bet throughout.
The most important thing to understand about Costco stock is that selling merchandise in bulk isn’t how COST makes its money. In 2018, the company reported $138 billion worth of goods.
The cost of those products plus the firm’s operating expenses totaled around $137 billion- leaving a profit of just $1 billion. However, the firm’s net income was over $3 billion.
That extra cash came from Costco’s yearly membership fees. In order to take advantage of Costco’s bulk goods and cheap fuel, customers have to pay a yearly membership fee, and that’s actually where the firm generates the majority of its income.
Why That’s Worth Investing In
The Costco business model makes COST stock a worthwhile addition to your portfolio for a few reasons. First, the membership-based model has helped the company avoid “the Amazon effect.” Costco’s membership program breeds loyalty and that loyalty translates into to renewals; the firm boasts a more than 90% customer retention rate.
That 90% retention rate is made possible by the firm’s business model. By selling its goods at-cost and offering fuel at a loss, Costco is building trust with its clientele. People expect Costco goods to be the lowest available price and that keeps them coming back.
Plus, Costco has been able to create an in-store experience that people are willing to pay for. First, there’s the “treasure-hunt” feel to the stores. While some items are always re-stocked, others like furniture and office supplies are one-time bargains. There’s also the company’s infamous sample stations and a variety of cheap meals at the Costco cafe. People like going to Costco and that’s another reason they’re willing to pay for a yearly membership.
Lucrative Way to Make Money
So, while Costco is technically a retailer the firm isn’t battling against the same issues as many of its peers. Instead the firm is benefitting from it’s high-margin membership fees. It doesn’t cost much to sign members up and collect their dues each year, so the majority of those fees are going straight to Costco’s bottom line.
Another thing Costco stock has going for itself is that its customer base is primarily affluent. The average Costco customer has an annual income of around $100,000, which has helped to insulate COST from market volatility in the past. The company’s value proposition is enough to keep its customers coming back even when the economy is down. The fact that the firm sells everyday necessities at a low price means people are unlikely to cut their membership when they tighten their pursestrings.
Costco stock is still recovering from a 12% drop back in December when the firm released its quarterly results. Investors were disappointed to see margins decline during the fiscal first quarter of 2019, but it’s worth noting that Costco has been investing heavily in its online platform in order to keep-up with the rising demand for online shopping options.
That kind of investment is hurting the company’s overall margins, but it’s paying off. Online sales were up 32.2 percent from the previous year. Plus, the key metrics that Costco’s overall business model relies on were strong.
Store traffic in the first quarter was up 4.9% worldwide and 5.2% in the US. membership revenue was up 10% from the previous year due to new sign ups as well as higher membership fees. The firm’s renewal rate in the US came in at 90.5% and 88% across the rest of the world.
Bottom Line on Costco Stock
The bottom line here is that Costco’s unique business model and wealthy customer base has insulated the store from problems that many of its peers are experiencing. The retail sector has enjoyed strong traffic in recent quarters, but an economic downturn could turn that around.
I’d argue that Costco is largely immune to that kind of risk, making it a solid play in the retail space. Plus, the worries about Costco’s margins back in December were overdone considering the strength in other areas- I’d expect to see the firm’s share price rise over the next few weeks as its earnings report date approaches.
As of this writing, Laura Hoy was long AMZN.