One of the big mistakes I made in my own portfolio was to sell Costco Wholesale (NASDAQ:COST) stock.
It happened in late 2017 when I was looking to raise cash. I sold my shares at $163. Now they’re trading at roughly twice that amount.
I have nothing against Costco. I love it. I’ve been a member since the white in my hair was a bad dream. I just thought I could get better growth elsewhere, and thus bigger gains. Over the long run, I haven’t.
Costco’s growth rate fell below 8% in fiscal 2019, in pre-pandemic August. But it accelerated during the pandemic to over 9%. Net income, which had been no more than the membership fees paid by customers, is now nearly 30% ahead of that figure.
Loyalty is One Key
Costco is the Walmart (NYSE:WMT) of the upper middle class. Walmart would like its Sam’s Club warehouses to hold that title. Reporters like to talk up the rivalry. But Sam’s is still trying to catch up.
For people with large homes and ample storage, Costco’s bulk items are a bargain. The stores stock luxury goods, too. They’re America’s top retailer of high-end wines. Where the law allows, their liquor is top shelf. They sell jewelry. They offer the best steaks and lobster. Their in-store rewards card, now a Citicorp (NYSE:C) Visa (NYSE:V), is a bargain as well.
It’s this reputation for bargains that is Costco’s secret sauce against even Amazon (NASDAQ:AMZN), according to Charlie Munger of Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B). To that, add a little less guilt. Costco recently raised its minimum wage to $16 and hour, well above rivals, and I see it every time I go there. It’s on the smiles of the staff.
That’s why a recent report on conditions at a company-owned chicken farm hit home. The same kind of piece, done against Walmart or Kroger (NYSE:KR), wouldn’t get the same reaction. After first dismissing the report. Costco said it would investigate.
Suburbs Are the Other Key
Another key to Costco’s success is its emphasis on suburban locations near freeway intersections. It can cost $100 million to build and stock a new store. The company has a rigorous process for new ones. If the demographics cease to line up Costco will also close stores or turn them into business centers with a different mix of goods.
It’s the regularity of Costco’s progress that draws investors. There’s growth in the high single digits, but also “special dividends,” like a payout of $10 per share last December While the regular dividend of 70 cents per share yields less than 1%, the special dividend raised last year’s yield to 3.8%, at today’s stock price.
The result is a stock that often looks expensive, with a price-earnings ratio of 34x, higher than even Apple (NASDAQ:AAPL). What makes up for it is an average capital gain of 24% per year over the last five years.
The Bottom Line
Costco works well when times are good. Costco also works well when times are bad.
This justifies the high price of COST stock. With a market cap of $146 billion, it’s still selling at a discount to sales, albeit a small one.
I wouldn’t make Costco my first stock purchase. When you’re young you accept risk in hopes of great reward. But once your retirement portfolio balance passes $500,000, and there are millions of Costco shoppers like this, the stock earns its keep.
I made a mistake selling my shares. Next time I look at the retail sector I might pick some back up. Too bad they’re not paying their credit card rewards in stock.
At the time of publication, Dana Blankenhorn directly owned shares in AMZN and AAPL.
Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, available at the Amazon Kindle store. Write him at [email protected], tweet him at @danablankenhorn, or subscribe to his Substack https://danafblankenhorn.substack.com/.