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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The $50 annual fee is discouraging.
Their appliances are well priced, but there is no range of options, and I see similar prices offered at major retailers for sale items.
We went to the gas pumps, and they don't accept cash, and take only Costco debit cards or American Express credit cards (which I don't use) so I left without even gas (which was only 6 cents cheaper than at the Shell station where I went after) and 6 cents is not a savings that excites me about Costco.
The point is - if I have this result, why pay $50 a year to be a member of a chain that sells things that does not sell the things that I need? The $50 is a barrier to trade since I won't pay it unless I can have confidence that Costco will stock what I need to buy, and since I don't have that confidence I won't be a member and I won't shop there.
Costco is a frustrating shopping experience, and that's the problem. No service, poor range of goods, quality is obviously variable (as is Walmart's) - and if I feel this way, I'm sure that others do also. That limits Costco's growth, and that reflects on the earnings multiple.
I shop both Costco & Sam's. I have to drive about 70 mi. to get to Costco and find that their selections are lacking in a lot of the products I use. Their prices aren't that much different from Sam's, generally only 1 or 2 cents.
I can save the price of my membership feeS just in the difference in the prices of OTC drugs that we use...ibuprofen, benedryl, tylenol, etc....and this is the difference in price from Walmart to either Sam's or Costco.
I'm not into organic (unless I grow it) and I don't care for a lot of the fancy stuff they sell. I really don't care for their fresh prepared foods section or their bakery items.
I do the majority of my bulk purchasing at Sam's! Besides, they are closer too....about 45 mi. away!
Just like anything else, it depends. Some things are better priced some are not. Also, you're gonna have to buy a 2,3,or 4 pack of something in order to get the better deal. I think people just have an affinity to the store & perceive like they're getting a better deal when in reality they're probably paying the same or more on alot of things.
I also find it hard to believe they are only breaking even on selling merchandise and their only real profit is from membership dues - that to me doesn't sound like a good business plan.
I read people's comments and look at the thumbs up and down, and it clearly shows that people that shops at Costco are like Costco, looks out for themselves. There is too much imported products in Costco. That is because the economy has gone down, and that everything is outsourced to other country for cheap. This country does not produce anything anymore, that is the problem with today's American unemployment. I read here business owner who was screwed by Costco. Costco does what Costco wants to do, and you can't tell them anything, they will tell business owners that they can only sell their products 10 weeks out of the year, and not depend on Costco to be their bread winner. So while the American consumer buy a product that is very successful at Costco, The American product it will only be supported for 10 weeks. It is a shame that American's who likes products that are produced in US have no say, yes members have no say in what products should be in the store. The membership fee is a fee that is basically paying for your discount in the store, so in reality your cheap products that you as a consumer purchase is not cheap anymore, you have already paid for the discount in advance by your membership. Don't think that Costco is doing you a favor.
I wish them well, but if they were replaced by Sam's in my town, I would not be very upset
I worked at costco for 14years and I lost my love for them. corp. management is good but on a store level it is sub par. I have seen store managers Break neearly every law on the books and like the catholic church they just move them to the next location or give them a slap on the wrist. In my store they fired all dept mgrs so the store mgr could make more on his bonus by saving payroll. They carry a very limited amount of merchandise and where they used to take pride in buying nearly all American they now buy mostly imported. They have gone the way of walmart. When I started it was see what you can do to help the people in your dept. do the job better. The last mgr meeting I attended we were told to tell the employees "If you don't like the way we do it here there are a thousand people out there to take there place, and pointed at the door. A complete 180 from when I started. The benefits have gone way down and I would imagine getting worse.
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