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Is Costco a Buy Following the Latest Pullback?

Tuesday, October 30th, 2012
By for Profit Confidential

Is Costco a Buy Following the Latest PullbackIn the retail sector, the competition has becoming increasingly fierce. The growth of online shopping has meant that many firms in the traditional retail sector have suffered. With margin compression, corporate earnings have been hit across the board. We’ve seen many retailers suffer over the last decade, but not all.

Costco Wholesale Corporation (NASDAQ/COST) has been able to create a very profitable niche within the retail sector. The company came up with an innovative business strategy—sell products at such a low price that people are willing to pay for a membership to join just to save. The company has grown massively within the retail sector, with a strategy of making extremely small margins but driving corporate earnings through membership sales.

The current profit margin is less than two percent, but corporate earnings are growing at a much faster rate. The company recently reported fourth-quarter and fiscal results for 2012. For the quarter that ended September 2, 2012, the company reported sales of $31.5 billion, a 14% increase from the prior year’s quarter. For the entire year, the company reported revenue of $97.0 billion, a 12% increase for the 2011 fiscal year. (Source: “Costco Wholesale Corporation Reports Fourth Quarter and Fiscal Year 2012 Operating Results,” Costco Wholesale Corporation, October 10, 2012.)

Corporate earnings for the fourth quarter were $609 million, a big increase of 27% from the $478 million during the same quarter last year. For the entire year, corporate earnings for Costco were $1.7 billion, an increase of 21% from $1.4 billion in 2011.

In a nutshell, what we’re looking at is a company within the retail sector that is seeing growth even in a weak economy. This stems from its business model that has extensive appeal to the average consumer. Offering goods at such a low profit margin is enticing people to pay for their memberships, from which the company derives a lot of corporate earnings. This also differentiates them from other online retailers that only generate corporate earnings from the low profit margins without any membership fees.

cost stock market chart analysis

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Chart courtesy of www.StockCharts.com

Costco has had a tremendous run this year. The stock has just recently broken its uptrend, as noted by the arrow in the chart above. While I do love the company, the stock is not cheap. Trading at a trailing price-to-earnings (P/E) ratio of almost 25, and a forward P/E ratio of over 19, the stock would need to have a little more of a pullback before I would step in.

This is the type of name that over a long period of time can be quite profitable if one were interested in being involved in the retail sector. This is because of the design of its business structure that appeals to many parts of the public and generates steady membership revenue. Looking out over the next decade, I think that looking for large pullbacks and favorable entry points could be a profitable investing strategy. With corporate earnings expected to continue to grow for an extended period of time, the question is not regarding the validity of its business model but rather where the favorable entry points are for accumulating the stock.

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Sasha Cekerevac - Investment Advisor, Fund AnalyzerSasha Cekerevac, BA Economics with Finance specialization, is a Senior Editor at Lombardi Financial. He worked for CIBC World Markets for several years before moving to a top hedge fund, with assets under management of over $1.0 billion. He has comprehensive knowledge of institutional money flow; how the big funds analyze and execute their trades in the market. With a thorough understanding of both fundamental and technical subjects, Sasha offers a roadmap into how the markets really function and what to look for as an investor. His newsletters provide an experienced perspective on what the big funds are planning and how you can profit from it. He is the editor of several of Lombardi’s popular financial newsletters, including Payload Stocks and Pump & Dump Alert. Add Sasha Cekerevac to your Google+ circles