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Costco: A "buy and hold" stock, according to Charlie Munger.

Opdateret: for 1 dag siden


Late Charlie Munger stated, "I love everything about Costco." "I'm a complete addict, and I will never sell a share." I understand why Charlie Munger felt that way, as Costco has a great business model and appears to be growing steadily. The question is at what price should you purchase Costco stocks? It is what I will investigate in this post.


This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.


Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.


For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Costco. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in Costco's competitors either. Thus, I have no personal stake in Costco. If you want to purchase shares or fractional shares of Costco, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.



Costco was founded in Washington, United States. They operate membership-only warehouses and e-commerce websites based on the concept that offering their members low prices on a limited selection of branded and private-label products in a wide range of categories will generate high sales volumes and rapid inventory turnover. Costco is the third-largest global retailer in the world and had 861 warehouses worldwide by the end of the fiscal year 2023. 591 of these warehouses are in the United States, while 107 are in Canada, 40 are in Mexico, 33 are in Japan, 29 are in the UK, 18 are in South Korea, 15 are in Australia, 14 are in Taiwan, 5 are in China, 4 are in Spain, 2 are in France, and 1 each in Iceland, Sweden, and New Zealand. In order to shop at Costco, you will need a membership card. Costco offers three different memberships: Executive membership at $120 per year, Business membership at $60 per year, and Gold Star membership at $60 per year. Costco has a total of 127,9 million members worldwide, and the retention rate of members is above 92% in the U.S. and Canada, and above 90% internationally. Costco offers a wide range of products including food and sundries, fresh foods, and non-food items. Additionally, some Costco locations provide services such as gasoline, pharmacy, optical, food court, hearing aids, and tire installation. Compared to other retailers, Costco has several operating efficiencies. One of these is that they sell fewer items, and these items are placed on pallets in the warehouse. This means that the handling time and steps from supplier to display is lower than that of their competitors. These operating efficiencies mean that Costco can sell its products at a lower price than its competitors. Costco has built a strong brand moat over the years, as exemplified by the continued growth of its memberships.


As I write this, their CEO is Walter Craig Jelinek. However, Walter Craig Jelinek will retire on January 1st, 2024, and the new CEO will be Ron Vachris. Ron Vachris has been at Costco for more than 40 years and started as a forklift driver. He subsequently worked in every major role related to Costco's business operations and merchandising activities, and he has been the COO for the past 2 years. We don't have much information about Ron Vacris yet, and he obviously cannot be judged as a CEO prior to him being in the role for some years. However, he does have vast experience in the company, and the current CEO, Walter Craig Jelinek, will remain with Costco through April 2024. Jelinek will serve in an advisory role and assist Ron Vachris during the transition, while also continuing to serve on the Board of Directors. Ron Vachris also serves on the Board of Directors and was chosen for this position due to his extensive knowledge of the company's business, which he developed over the course of his long career with the company. His expertise lies specifically in the areas of operations and merchandising. It is qualifications that he can use as a CEO as well. There are always uncertainties with a change in management, but due to Ron Vachris' extensive experience at Costco, I am confident that he will do a great job.


I believe that Costco has a moat, and despite the uncertainties, I feel confident with the new CEO. Now, let us analyze the numbers to determine if Costco meets our criteria for possessing a strong competitive advantage. In case you want an explanation of what the numbers represent, you can refer to "MY STRATEGY" on the website.


The first number we will investigate is the return on invested capital, also known as ROIC. I would like a 10-year history with all figures exceeding 10% for each year. Costco has consistently achieved a ROIC (Return on Invested Capital) of over 10% in the past ten years, which is encouraging to see. Another encouraging trend is that the Return on Invested Capital (ROIC) has been above 20% in the past three years, which is unprecedented. ROIC did decrease slightly in fiscal year 2023, but considering all the macroeconomic challenges, it is not a concern. Costco is close to being a textbook example of how you would like to see the ROIC (Return on Invested Capital) of a company. It is well above 10% in all years and has been growing from 11,8% in 2014 to 20,7% in 2023. Although the growth hasn't been linear, it is still impressive.



The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Overall, the numbers look good. There were years when the equity decreased, but if you look at the growth from 12.887 in 2014 to 26.309 in 2023, the growth has been impressive as it gives a compounded annual growth rate of more than 7%.



Finally, we will investigate the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow margin is used because I believe that margins provide a better understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. It is not surprising to see that Costco has consistently generated positive free cash flow every year for the past decade. Looking at the actual numbers, we see that Costco generated its highest free cash flow ever in fiscal year 2023, which is encouraging. The levered free cash flow margin is low, but there is an explanation for that. Costco generates most of its revenue through product sales, while their profits primarily come from membership fees. Thus, the levered free cash flow margin is low despite Costco being a highly profitable company. The free cash flow yield is slightly higher in fiscal year 2023 than in fiscal year 2022, but it is not as high as before and is below the ten-year average of 2,8%. Hence, the free cash flow yield indicates that Costco shares are trading at a high price. However, we will discuss this further in the analysis.



Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After performing the calculation on Costco, I found that the company has 0,85 years of earnings in debt. It is within the three-year timeframe, so debt is not something I worry about.



Based on my findings thus far, I believe that Costco is an intriguing company. However, no investment is without risk, and Costco also has its fair share of risks. One risk is competition. Costco operates in a highly competitive industry that is based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. Costco competes on a worldwide basis with global, national, and regional wholesalers and retailers. Some of its largest competitors include Walmart, Target, Kroger, and Amazon. Furthermore, the evolution of online and mobile retailing channels has improved customers' ability to compare prices, thereby enhancing competition for Costco. Another risk is macroeconomics. Factors such as increased energy and gasoline costs, inflation, unemployment rates, healthcare expenses, consumer debt levels, and weaknesses in the housing and real estate markets affect consumer confidence, which in turn negatively impacts Costco. It has particularly hurt e-commerce sales, as Costco has experienced a decrease in sales for big-ticket discretionary items such as home furnishings, small electronics, jewelry, and hardware. These departments account for over half of Costco's e-commerce sales. Another risk is the failure to maintain membership growth. Membership loyalty and growth are essential to Costco's business. The extent to which Costco achieves growth in its membership base, increases the penetration of Executive membership, and sustains high renewal rates materially influences its profitability. This is because the majority of Costco's profits come from its membership fees, despite these fees accounting for less than 2% of its revenue. Thus, if Costco fails to continue maintaining membership growth, it will affect profitability.


There are also numerous reasons to invest in Costco. One reason is the growing membership fee. Costco continues to grow its membership. Costco ended fiscal year 2023 with 7,6% more cardholders than at the end of fiscal year 2022. This resulted in an increase in membership fees to 1,95% of revenue in fiscal year 2023, compared to 1,90% of revenue in fiscal year 2022. Furthermore, Costco usually increases the membership fee approximately every five years, but they have not increased the membership fee for six years now. Management has mentioned that it is a matter of when, not if, they will increase prices on the membership fee. Once they do so, it will enhance the profitability of Costco. New warehouses. Costco continues to open new warehouses. In fiscal year 2023, they opened 23 new warehouses, including 13 in the United States and 3 in China. Costco expects to open around twenty-five new locations again in fiscal year 2024. Costco doesn't plan to stop opening new warehouses and expects that there is room for at least 150 warehouses in the United States. They also plan to open more warehouses in China, as management stated that their openings in China has treated them well. New warehouses will result in new members, which will increase the membership fee. Costco Next. Costco Next is Costco's drop-shipping business. Drop-shipping is usually a higher-margin business, as the seller doesn't need to keep stock on hand. Costco hasn't shared the margins on Costco Next, but I assume they are higher than those of warehouses. Costco Next continues to grow, and management has mentioned that they continue to onboard new suppliers for Costco Next. Hence, if Costco Next continues to grow, it could potentially boost profits for Costco.



Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.


The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 14,16, which is from fiscal year 2023. I have selected a projected future EPS growth rate of 11% (Finbox expects EPS to grow by 10,9%). Additionally, I have chosen a projected future P/E ratio of 22, which is twice the growth rate. This decision is based on the fact that Costco has historically had a higher P/E ratio. Lastly, our minimum acceptable rate of return is already set at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $218,64. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Costco at a price of $109,32 (or lower, obviously) if we use the Margin of Safety price.


The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The operating cash flow last year was 9.849 and capital expenditures were 4.026. I attempted to review their annual report to determine the percentage of capital expenditures allocated for maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 2.818 in our calculations. The tax provision was 2.195. We have 442,793 outstanding shares. Hence, the calculation will be as follows: (9.849 – 2.818 + 2.195) / 442,793 x 10 = $208,36 in Ten Cap price.


The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Costco's Free Cash Flow Per Share at $15,22 and a growth rate of 11%, if you want to recoup your investment in 8 years, the Payback Time price is $200,36.


I believe that Costco is an intriguing company. There are some uncertainties regarding the management, but the new CEO has been at Costco for four decades and has held various management positions. Therefore, I will give him the benefit of the doubt. Costco is operating in a highly competitive industry, but I believe that their unique business model protects them from competition, so it isn't something I'm overly concerned about. While macroeconomic factors do hurt Costco, these will eventually improve. Maintaining membership growth is essential for Costco. While they have managed to do so historically, and I believe they will continue to do so, it is something that needs to be monitored when investing in Costco. Costco has many factors that make it an intriguing investment as it continues to grow its membership fee. Additionally, once they decide to increase prices, it will have a positive impact on their profitability. Costco continues to open new warehouses, which will result in an increase in membership. They still have a long runway to open warehouses in the United States, and an even longer runway internationally. Finally, Costco Next is also growing, which could potentially increase profitability. I understand why Charlie Munger liked the business, and I would also love to own shares in Costco. I don't think Costco will ever trade at a discount, but I don't want to purchase shares above their intrinsic value. Thus, I will buy shares in Costco if it reaches the intrinsic value of the Ten Cap price, which is $416,70.


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I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.


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