1 Retailer Is Head and Shoulders Above ALL Others

Some businesses have all the hallmarks of being average. A grocery store fits squarely into that category because goods are bought at wholesale prices, sold at retail, and the margin must cover all the other costs of the business from real estate costs to labor and everything else in between.

And then there’s Costco, a company with a business model so unique it even attracted the interest of Buffett’s right-hand man. But what exactly is it that Costco does so much differently than all its rivals?

Key Points

• Costco’s business model relies on an annual membership fee which in turn results in more predictable revenues.
• The retailer enjoys higher margins and profitability than other competitors.
• Costco has a wide moat that few other firms can encroach upon as a result of higher customer retention and lifetime value.

Why Costco Is Unique

It’s well-known that Costco has a membership model but what’s not so commonly understood is why that is so innovative. The first thing to note about the membership is the renewal rate, which stands at over 90%, meaning customers are delighted by the Costco product featuring low cost goods sold in bulk.

By keeping customers happy, a key attribute Berkshire Hathaway looks for when investing, Costco gets to spend less on marketing and sales campaigns, thereby adding to its margins and contributing to higher profitability.

The annual fee also means that Costco has a much more steady flow of revenues that are highly predictable versus the average retailer. That membership also locks customers in willingly to purchase goods at Costco for the coming year. Why would they shop elsewhere when they have already spent money on a membership fee to gain access to lower cost goods. The same cannot be said of other retailers.

As a result, each customer at Costco is worth more than each customer at a rival chain because, on average, they spend more per year at Costco, leading to higher customer lifetime value.

A domino effect occurs where the membership fee translates to steadier revenues than rivals, higher retention among customers, lower marketing costs, and higher profit margins.

But that’s not all.

Why Costco Can Deliver Higher Profits

The membership fee is the golden goose, but it’s simply the toll that members pay to gain access to Costco stores. Once inside, another key attribute of Costco’s business model is crucial to profitability, and that is the Kirkland Signature private label brand, ranging from home goods to groceries.

Unlike so many other private brands, Kirkland Signature is viewed as a higher tier brand, leading to higher customer satisfaction but also higher margins for Costco.

Add to the mix the highly conservative financial management of the firm that enjoys 3x more cash than debt on the balance sheet, and you can see why savvy investors are attracted to the firm. It’s got a wide moat, a loyal customer base, a fortress balance sheet and a business model that is not easily emulated by rivals.

Is Costco a Buy?

Costco’s business model is exemplary but 15 analysts have revised their estimates lower for the stock, and a cash flows analysis explains why pessimism has grown with fair value sitting about $120 lower than the present $640+ per share level.

If they are right, Costco share price may run into choppy waters this year but keep it on your radar because if it crosses below that fair value threshold, it could offer great potential for the future.