Why Costco lures shoppers -- and investors

The warehouse chain's strategy of appealing to a wide swath of customers -- and charging lucrative membership fees -- is paying off.

By Jonathan Berr May 31, 2013 10:36AM

Costco Wholesale's (COST) hybrid approach that merges direct-to-consumer retail and bulk purchases to small businesses continues to be successful. The company’s better-than-expected earnings report yesterday underscores that point.

Net income surged 19% in the latest quarter to $459 million, or $1.04 a share, from $386 million, or 88 cents a share, a year earlier. That beat the $1.03 per share profit analysts had expected. Revenue rose 7.9% to $24.1 billion, missing forecasts of $24.2 billion.


Investors, though, are willing to overlook this stumble because of Costco's unique business model that lures in consumers with prices for staples such as food, gasoline and generic medicines that are at or below cost. The chain makes its profits by selling memberships to its 627 stores around the world. That business continues to grow like gangbusters.


Membership revenue jumped 12% to $531 million in the most recent quarter. Even more impressive was the 19% gain in new member sign-ups, an indication of the company’s successful expansion into Japan. Renewal rates are about 90% when factoring in both business and individuals, showing the chain's sustained popularity.


A Costco employee cooks chicken at Costco in Mountain View, Calif. on March 2, 2010 (© Paul Sakuma/AP Photo)And Coscto has aggressive expansion plans. During the current fiscal year, it will add 28 new stores, up from 12 in the year-earlier period.


One of Costco's biggest advantages is that it appeals to many different types of customers. Budget-conscious shoppers and small-business owners flock there for its low prices, while those with more cash to spend can buy big-ticket items such as home electronics, furniture and, believe it or not, even caskets. While shoppers are checking out chocolate cakes that can feed a small army, they can get their car's tires changed or peruse travel deals.


Costco shares aren't cheap, trading at a price-to-earnings multiple of 25.81, which is a premium to Target (TGT) and Wal-Mart (WMT), whose valuations are both under 18.

Investors, though, will find that Costco is worth the money. Its same-store sales, excluding foreign exchange rates and fluctuations in gas prices, surged 7% in the latest quarter. That was a far better performance in this key retail metric of sales at stores open at least a year than Wal-Mart, which posted a 1.4% U.S. same-store sales loss in its most recent quarter. It also handily beat Target, which posted just a 1.6% gain.


Investors should wait for the stock to pull back some before pulling the trigger. Getting Costco shares at a better valuation should prove as good as any deal you'll find in the company’s aisles.

Got any questions about this or any other "Killer Companies" episode, or suggestions for companies to cover? Drop us a line in the comments section.

Jonathan Berr owns a small stake in Costco. Follow him on Twitter @jdberr.

May 31, 2013 11:23AM

I hope Costco puts Sams Club out of business, they have a CEO who realizes that you should pay workers a livable wage and gives health benefits to everyone rather than padding his own salary. On top of that one of the more successful businesses around, very low turnover and from what I have heard, a great place to work.


This shouldn't be an anomoly, but sadly in America it is - what exactly does a CEO do that is worth the yearly salary of 1000 employees I wonder?

May 31, 2013 12:28PM

Costco is a great company because co-founder and former CEO James Sinegal believed that employees were the key to a successful company and he didn’t just talk the talk about treating employees right and paying them well, an average of over $40,000/year, he walked the walk.  He stood his ground to shareholders that thought employees should be paid less and have less benefits, and now these stockholders are smiling all the way to the bank with great quarterly earnings while other companies make excuses for low sales.  New CEO  Craig Jelinek continues this philosophy.  In return, Costco attracts a more professional workforce , with an incredibly low turnover of about 5% .  These workers want to go the extra mile for the customers and the company, as they feel as valued by their company.   Costco doesn’t forget that their members willingly pay a membership fee and the company tries to give them a good shopping experience with higher quality merchandise and variety.  Costco also attracts a wide range of members, including the all important higher income members who aren’t as affected by downturns in the economy, as are moderate income shoppers.  Costco is a good corporate citizen because employees are paid a living wage, so employees’ wages do not need to be subsidized with taxpayer funded Medicaid and food stamps.

May 31, 2013 11:39AM
If you just go for the gas its a winner. Everything I buy at Costco works so it apears the stuff is all tested before its sold to customers. You also cant beat the $1.50 hot dog and coke combo.
May 31, 2013 11:48AM

I like the idea of employee retention. Nice to see familiar faces. Means they are reasonably happy with the workplace. I read somewhere, the only competition Walmart is worried about is Costco.

May 31, 2013 12:08PM
The worker satisfaction and training is a apparent while shopping at Costco, whereas if you go to Target, Walmart, KMart, you find ill trained unhelpful workersat minimum wage with no or little benefits and it shows. I value the way employees are compensated and love to support them by owning shares and shopping at Costco.  Great prices + good quality products.  Now, Costco, please have an express line! 
May 31, 2013 12:19PM
I don't know much about COSTCO as an investment opportunity but really like them from a customer's point of view.  The employees are generally happy because they get decent pay and benefits.  Prices are good even if not terrific.  Combine happy employees and reasonable prices and you have a good shopping experience.  Wal-Mart, on the other hand, treats their employees poorly and that flows through to the customers too.  I've never encountered a rude employee at COSTCO but seem to run into some grump every time I go to sprawl mart.  Shopping at COSTCO is worth the 40 mile drive.  Wal-Mart is one mile away and when I have to go there it's a real pain.
May 31, 2013 12:33PM
Costco is not for all shoppers. We buy certain items of food, prescriptions, TV's, computers, appliances, clothing, Christmas items and outdoor furniture. We have an executive membership with cash back once a year which is always way more than membership cost. We never throw any food away because we freeze the extra and use when needed. On the very rare occasion we have to return an item, it is refunded with no grief.
May 31, 2013 12:24PM
we have executive card - payback % almost pays our membership cost
May 31, 2013 1:28PM
I shop there because they have good products, good prices AND helpful, friendly, customer oriented service. A very rare commodity these days.
May 31, 2013 1:41PM
I mean a whole rotisserie roasted chicken the tastes awesome and isn't fried in fat and doesn't have grease soaked coating for 5 bucks.  AWESOME!!!!!

May 31, 2013 1:41PM
When you run a store efficiently, treat employees with respect and serve the community in a fashion that gives them what they NEED, you make money. Pretty simple.
May 31, 2013 11:37AM

50 pound sack of rice, 25 pound sack of pinto beans and 20 gallons of milk can be purchased at costco for $100 or less.


This is enough to feed a person for about 6 months, and we think we still a foodstamp program, this proves they just exist to buy votes.

May 31, 2013 1:39PM
Costco has great prices and sells quality stuff.  That is why they are so successful.  Pretty easy to understand actually.
May 31, 2013 12:57PM
I love Costco, I think it is a great store for people with large families. I used to spend every Saturday shopping for weekly groceries when I had kids at home. Now that there is just two of us, it does not behoove us to have large packages of food items. Bread comes in two packs and we barely finish one loaf. I cannot see wasting a loaf of bread (even though the cost is the same at my local market for one loaf). Unless we want to eat the same vegetable each night for a week , I  no longer buy the produce as the packages are huge. I mainly purchase cleaning supplies or paper products for events. Again, I love Costco, but it just no longer fits into my weekly needs at this stage of my life. 
May 31, 2013 2:32PM
Look.. a Business that pays their workers ABOVE minimum wadge and provides them with health care.

Looks like the ' if we raise the minimum wage business will suffer' crowd are full of it. Just like with providing health care!

May 31, 2013 1:27PM
coscto doesn't always have the best prices and buying in bulk isn't always the best  for food that will spoil quickly,to shop at coscto you need to know how much things cost and then compare the per unit price to see if you are getting a good deal and don't forget to include the price of your membership,it's good for some things but bad for others
May 31, 2013 11:54AM

All previous comments agreed , But Costco has consistently raised prices for multiple food items and the gap for bulk prices vs retal prices at other stores has norrowed considerably, to a point that it makes no sense to buy the bulk items anymore. Also, in the food category, they have in  the name of better product, created a line of premade foods and pasta while reducing the inventory of ingredient items or uncooked items. All snack items used to bei the range of 5-8 dollars and all those things with different packaging and lesser weight are now at 9-14 dollars. Almost doubling the prices.


In the fruits, the prices have almost doubled for some items and the quality has gone down, especially for grapes, stawberries etc that i have noticed.  


You can still get good deals at Costco however they are now reducing.


Costco has stretched the price elasticity to the maximum and unless they control it, the numbers will be going down from here.

May 31, 2013 2:33PM
The quality of merchandise is superior to Wal-Mart, the prices are good and you are not subjected to "Walmartians" to ruin your shopping experience.
May 31, 2013 1:58PM
I love shopping at costco for meat.  The whole untrimmed beef tenderloins are an awesome deal.  For $90 you get 10 good sized filet mignon steaks, another small roast that can feed 3 or 4, and some meat to turn into shredded beef for tacos.  Whole pork loins and the chicken breasts are also great deals.
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