On a day that saw the S&P 500 rise by 9.4% in a bit of a relief rally, Costco (NASDAQ:COST) fell by 0.21%. If that’s not a sign that Costco stock has become the ultimate defensive play, nothing is.
It Has a Sustainable Business Model
Long term, what does this mean for the discount retailer? Can it carry this momentum through the remainder of 2020 and into 2021? I think it can. Here’s why.
Costco’s business model is simple. Drive a ton of people to your stores, get them to buy a boatload of what’s on your shelves, and keep them coming back. Rinse and repeat.
But how do they do that?
First, they drive a hard bargain with their suppliers to keep prices low. In uncertain times, that’s a lifesaver. As a result, people are flocking to its stores to keep the home fires burning. And it doesn’t hurt that Costco’s customers have an average household income of $74,000. This demographic is more likely to have white-collar jobs and be working from home at the moment.
Another thing that separates Costco from its peers is the fact it treats its employees so well. In September 2018, I recommended Costco as one of seven stocks to buy to make America great again.
My rationale had everything to do with the way it treats its employees. And the fact it continues to hire lots of Americans.
“What I find interesting is that over the past five years, Costco’s grown its number of full-time employees by 29% and part-time by 21%,” I wrote in 2018. “Critics of retail companies and the jobs they create often point to the fact most of them are part-time and lower-paying. The stats over the past five years would suggest otherwise.”
As far as I’m concerned, one of the best barometers of a good company is the number of employees it’s hiring each year. If the number is going down, not up, the company’s in cost-cutting mode and that’s most often a sign of a declining business.
Costco is most definitely not that.
Members Drive Costco’s Business
Getting back to its business model, the company runs razor-thin gross margins on its products, knowing that it wins through volume buys from its members.
Here’s what I had to say about Costco’s business model in 2013. Nothing’s changed.
“I believe Costco’s business model is about as smart as they come. By using razor-thin margins to attract customers, the company never has to worry about traffic to its stores. As long as people continue to buy in bulk, I don’t see how it can stop growing,” I wrote in March 2013.
I recommended investors buy its stock. It’s up 177% since, not including dividends. That’s some return.
However, the best part of Costco’s business model has always been its membership.
In my 2013 article, I mentioned that Costco had just delivered 15% membership growth in its second quarter. Fast forward to Q2 2020. The retailer’s total paid members increased by 4.9% to 55.3 million from 52.7 million a year earlier. That might seem like a big comedown from 2013, but you’re talking about seven years of growth passing in the meantime. It was bound to slow.
More importantly, its membership fees of $816 million represent just 2.13% of its sales. Now, look at its pre-tax income ($1.28 billion), and you realize that membership fees accounted for 64% of its pre-tax profit.
As long as Costco continues to grow its membership base by a few percentage points each year, it remains a fantastic stock to own in good times and bad.
The Bottom Line on Costco Stock
Cowen recently stated that it believes the coronavirus-related surge could last for months delivering double-digit earnings growth in the near and medium term. That’s based on membership growth, square-footage growth and tremendous growth of its in-store traffic.
As if Costco needed any help. The current situation is just icing on the cake for long-time shareholders.
In early February, I argued that Costco stock was worth more than $312, the average target price of Wall Street analysts. Since then, it has lost about 6% of its value. That compares to a 25% decline for the SPDR S&P 500 ETF Trust (NYSEARCA:SPY).
Since the coronavirus outbreak, nothing has changed. I still feel it’s worth a lot more than $312. But more importantly, the statement above shows why Costco is the ultimate defensive play.
Costco is a buy at these prices.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. As of this writing, he did not hold a position in any of the aforementioned securities.