Charlie Munger's love affair with Costco
The anatomy of a great company.
By Morgan Housel
Asked about his favorite company outside of Berkshire, Munger literally interrupted the questioner and answered, "That's easy. It's Costco."
"It's one of the most admirable capitalistic institutions in the world. And its CEO, Jim Sinegal, is one of the most admirable retailers to ever live on this planet," he gushed. "I just can't say enough about my admiration for Costco. More of you should look at Costco. In fact, every time Donald Trump says something and you get discouraged, you should think about Costco."
He wasn't done. "It has a frantic desire to serve customers a little better every year. When other companies find ways to save money, they turn it into profit. Sinegal passes it on to customers. It's almost a religious duty. He's sacrificing short-term profits for long-term success."
This wasn't the first time Munger let his admiration run wild. Last year he said, "Generally speaking, I believe Costco does more for civilization than the Rockefeller Foundation."
What's behind these accolades?
Part of Munger's obsession with Costco is its corporate culture. "It's a total meritocracy," he said. Co-founder and CEO Jim Sinegal earns a few million a year -- a rounding error in the corporate executive world -- answers his own phone, spends 200 days a year visiting stores, and strikes you as a retired middle-class neighbor more than the head of one of the world's largest companies. Costco employees don't wear uniforms. Street clothes and a nametag get the job done -- an idea that saves money while humanizing workers. "Our intention is to try to build an organization that is going to be here long term," Sinegal told The Motley Fool two years ago. "And we think you do that by paying attention to some very, very basic things."
Those things, in order, are: Obey the law, take care of your customers, take care of your people, and respect your suppliers.
Shareholders, you'll notice, aren't part of the list. But that hardly means they're forsaken. Costco might be one of the best examples of how happy customers and employees naturally lead to happy shareholders. Sinegal likes to note that Wall Street constantly jeers Costco for being more generous to employees than shareholders, yet its stock consistently trades at one of the highest multiples in the retail industry, well ahead of Home Depot (HD) or Wal-Mart (WMT). Since 1995, Costco has returned 1,000% to shareholders; the S&P 500, less than 200%. Whatever Costco's doing -- deliberately shareholder-centric or not -- works.
The rest of Munger's admiration has to do with Costco's business model.
Retailing is a simple industry. You sell merchandise for a little more than you paid for it. The difference, minus the cost of operating the store, is profit.
Costco is different. It doesn't make much money from retailing. Revenue from retail sales comes precariously close to matching cost of goods sold plus operating overhead:
Cost of goods sold
Source: Company filings.
Those margins are so thin they're nearly irrelevant. For comparison, Wal-Mart's margins are almost 6%.
The winners, of course, are Costco's customers. Take a company that prices goods just barely high enough to cover overhead costs, add in the natural savings from selling in bulk, and the odds are overwhelming that Costco customers are getting the lowest prices possible. That, in essence, is the company's goal -- or religious duty, as Munger would say.
The lengths it goes to to uphold that goal are nearly boundless. In 2009, Costco wasn't happy with Coca-Cola's (KO) prices. Rather than stick customers with higher costs, it simply stopped carrying Coke products altogether. "At this time, Coca-Cola has not provided Costco with competitive pricing so that we may pass along the value our members deserve," read signs over empty store shelves. Most retailers ask how high they can push prices without sacrificing sales. Costco asks how low it can push them while still covering operating expenses.
All the while, the company is still quite profitable. The secret is that essentially all its profits come from membership fees. Total net income in 2010 was $1.3 billion; membership fees that year were $1.7 billion. The year before, total net income came in at $1.1 billion; membership fees, $1.5 billion. That's Costco's deadly weapon: price goods cheaper than any competitor reasonably can, but still reap respectable profits off membership fees.
It's a win-win for members and shareholders. For an average member who spends $1,200 a year at Costco, membership fees -- as low as $50 a year -- aren't much, and well worth it financially. For shareholders, 63 million of those membership fees, with a renewal rate of 88%, equal big, stable profits. And there's a psychological benefit to the membership model: Paying a token fee once a year and enjoying cheap goods year-round feels better than buying average-priced goods all the time.
The question is whether Costco stock deserves your money. "The world has figured Costco out, which is why it trades at 25 times earnings," Munger said. "If you're comfortable with that, Costco is one of the most admirable capitalistic institutions in the world."
Valuation is what has always kept me away from the stock. At some point, however, you have to get comfortable with paying for quality. Costco is a terrific company. Is it worth the price? You tell me in the comments section below.
Fool contributor Morgan Housel owns shares of Berkshire and Wal-Mart. The Motley Fool owns shares of Costco Wholesale, Berkshire Hathaway, Wal-Mart Stores, and Coca-Cola. Motley Fool newsletter services have recommended buying shares of Wal-Mart Stores, Costco Wholesale, Coca-Cola, Home Depot, and Berkshire Hathaway. Motley Fool newsletter services have recommended creating a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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Prior to Chemo, my Dr. handed me a list of prescriptions designed to help prevent the side effects of Chemo. I priced the generic brands at several of my local grocery stores and chain pharmacy stores and was horrified that the prices ranged from $230.00 to $130.00 for 24 pills. As an afterthought I called Costco. What a shock! The price for the very same 24 generic pills was $25.00. Needless to say, I am forever a Costco Fan. I was also informed by the very friendly staff that anyone (even non members) can purchase their prescriptions at Costco and save Tons of $$$.
Since then, I always do my homework before making any purchase over $100.00 and 99% of the time Costco wins and the quality is always top notch. In addition, my local Costco always has the lowest gasoline prices... As long a Costco is around, I will continue to pay the $50.00 renewal fee and continue to save.
You won't find any slacker employees on the floor of Costco. Always energetic and knowledgeable! The merchandize turnover and product changes they have in there also makes it an interesting place to shop with what they carry now that they did not have last month. It's a fun place to shop!
I love Costco. I wasn't sure we would use our membership as often after our girls left home, but I use it so much that we upgraded to an executive membership. The savings on electronics and jewelry are amazing and I can't buy high quality steak or seafood anywhere for the price that I can buy it at Costco. I buy Christmas and birthday gifts there and I can buy a much nicer gift for the same money I might spend at Target or Penney's.
I buy all my staples at Costco. I just wish they had the half-caf Folgers coffee that I use. I'm forced to pay ridiculous grocery store prices, but it's a sacrifice I'm willing to make--lol.
I suspect those that dislike Costco are the sorts that need their hand held and think that the warehouse feel is beneath them. I'll take a warehouse with cheap prices over a grocery store with Musak and fancy displays any day.
We always shop Costco first. Love the "top of the line" Kirkland brands. We also belong to
Sam's Club, but hate to shop there. Sure wish Costco would build a store in Ft. Wayne, Indiana, I do get tired of driving 100 miles to Indianapolis just to shop at Costco.
I have been Costco customer for almost 20 years by now, I have spent a lot money at Costco, never regret with the quality and prices. Going there to shop things like you got things with insurance, you can count on its quality and good price. it is not cheapest price, but good value in term of quality and customer service. I even have several FRIENDS at store where I go all the time. I buy everything at costco, they have best value on steak, seafoods, furnitures, watches and Jewelry and even phone services. If you are looking for cheapest goods, then Costco may not be the place you should go. It is a place to go if you appreciate top qualities with good prices. This combination has kept me going there almost 20 years. Matter of fact, the first thing we worried when I moved from big city to country side was if I could still shop at Costco, it turned out there is one about 30 minutes out, so we made a decision to move where we are today.
Costco has become staples in my family life for a long time, and my children now are out of colleges and on their own, one of the things that I bought for them when they were away from me was Costco membership cards. I just bought a nice ring for my mother from Costco, how you can beat that price elsewhere. To me, If you can find a place where you can get to Costco without too much trouble, plus Wegmans or Harris Teeter for things that Costco doesn't carry, then you are OK. That is how impportant Costco to me, I am sure it is true to many people like me.
like anywhere , you do have to do a little homework .. or at least retain some info on prices elsewhere. Some things are a great deal and we go for them .. others i know wont be so we don't get that item. the bulk of our weekly shopping is done elsewhere , costco is a once a month trip for generally the same items
tigerpilot: I don't know where your Costco is but our gas pumps take debit cards. I am an executive member & get 2% back on all my purchases. The employee even told me when I signed up if I didn't get XXX amount back @ the end of the year to lower my membership. WHAT BUSINESS IS THAT HONEST?! And I know 2% isn't much but I shop there anyway why not get back something?! I have never found any store that beats their prices for electronics & if they do they match their price.
I wait for their coupon book & take advantage of that by going only once a month because it's true somehow it does become the $300 store.
I HAVE NEVER HAD A RUDE EMPLOYEE EVER and have been to 3 different Costco's in 3 different states.
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