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Stepan Lavrouk
Stepan Lavrouk
Articles (177) 

Charlie Munger Loves Costco; Should You?

It has great customer loyalty, but is it too expensive?

Investors in wholesale retailer Costco (NASDAQ:COST) have been richly rewarded over the last year. The stock is up over 25% year-on-year, significantly outperforming the S&P 500 over the same period (5% return). Not a bad showing for a company with a market capitalization of almost $100 billion. Shares of Costco are currently trading at all-time highs. What has driven this growth?

Strong showing in a tough market

Costco has shown remarkable resilience in an industry that has been subjected to increasing pressures from online retail. Amazon (NASDAQ:AMZN) has obviously put many a brick-and-mortar retailer out of business, but companies like Walmart (NYSE:WMT) and Target (NYSE:TGT) have also invested heavily in their online offerings. Despite this tough environment, Costco has done well.

In its annual report for 2018, the company reported that it was able to grow memberships to 51.6 million from 49.4 million, despite the U.S. (its core market) being largely saturated at this point. Membership renewal rates in the U.S. and Canada were 90%, and 88% globally. All of this translated to an average sales increase of $21 million per warehouse. As Costco sells products at close to break-even price, its main source of profit (apart from its own Kirkland Signature brand) are its membership fees. For this reason, growing the number of members, and retaining existing ones is of paramount importance.

Charlie’s favourite

An interesting side note is that Charlie Munger (Trades, Portfolio) is on the board of directors for Costco (and has been since 1997), and owns over 180,000 shares in the company. While this is not a reason to buy a stock (always do your own research and never blindly follow anyone, regardless of their track record) it makes sense that Munger would like Costco -- it is mature businesses with great customer loyalty and very sensible management. And he doesn’t just like Costco -- he loves it. He has called it his favorite company outside of Berkshire Hathaway (BRK. A)(NYSE:BRK.B) and “one of the most admirable capitalistic institutions in the world.”

A bit too expensive?

However, Munger’s high praise cannot change the fact that Costco is valued extremely highly at the minute. Its current price-earnings ratio of 32 significantly exceeds that of the S&P 500 as a whole (21), and of its own historical average (26.5). Moreover, Costco’s sales growth has actually slowed over the last six months, which is at odds with the premium the market seems to be pricing into the stock price. This high valuation will put Costco in a vulnerable position should a recessionary environment come about, as consumer spending will slow down.

Summary

Overall, we think that Costco’s valuation is very high. That isn’t to say that it won’t do well, and that it won’t continue to attract members. The way we see it, if you want to buy a slice of American retail that will probably be around for a long time, then Costco is worth a look. But for a value investor, the current valuation is just too high to justify getting involved.

Disclosure: The author owns no stocks mentioned.

Read more here: 

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Peter Lynch: Improve Your Edge 

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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