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Why Charlie Munger Loves Costco

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Wednesday, 17 October 2018 01:58 PM Current | Bio | Archive

Most investors know Charlie Munger as the Vice Chairman of Berkshire Hathaway (BRK.B) and one of Warren Buffett’s partners. But what you may not know is that Munger is also on the Board of Directors of Costco Wholesale Corporation (COST).

Munger and Buffett look for businesses with long-lasting competitive advantages and economies of scale. The Charlie Munger quote below shows why:

“Let’s go through a list – albeit an incomplete one – of possible advantages of scale. Some come from simple geometry. If you’re building a great circular tank, obviously, as you build it bigger, the amount of steel you use in the surface goes up with the square and the cubic volume goes up with the cube. So as you increase the dimensions, you can hold a lot more volume per unit area of steel.

And there are all kinds of things like that where the simple geometry- the simple reality- gives you an advantage of scale.”

Costco’s highly profitable business model and economies of scale make it a natural fit for Munger.

The Secret To Costco’s Success

Costco is a discount retailer that operates more than 760 warehouses around the world. The company generates approximately $150 billion in annual sales. Costco has built itself into one of the largest warehouse retailers in the world. It has developed a strong brand, through a strict policy of low prices and high customer satisfaction. At Costco, shoppers aren’t customers, they are members, which has generated a great deal of brand loyalty. From 2013 through 2017, Costco’s total memberships grew from 39 million to 49.4 million. This has driven impressive sales growth: from 2008 through 2017, Costco’s total sales per square foot rose from $137 to $163.

Membership growth is the key to Costco’s rising earnings in recent years. Earnings-per-share increased 14% in 2017, and rose at a 7% annual rate since 2013. Membership fees are a very valuable business for Costco. Membership helps drive brand loyalty, and results in a continuing source of revenue growth. The membership business is also high-margin, compared with the low-margin retail business.

Costco generated its high membership growth due largely to its focus on low prices, made possible thanks to significant economies of scale. As Costco grows its store count, it can procure better terms from suppliers and reduce operating costs as a percentage of revenue. For example, from 2013 to 2017, Costco’s gross margin as a percentage of net sales expanded from 10.62% to 11.33%.

At the same time, investors might naturally assume economies of scale means reducing costs everywhere, including labor costs. But Costco has taken a much different approach than some of its competitors in the discount retail industry. Costco prides itself on paying above-average wages and benefits to its employees. This actually works to the company’s benefits, as loyal employees tend to perform better, helping to increase customer satisfaction, and result in lower turnover costs. Costco certainly has not been hurt by this—comparable sales increased 9.5% in fiscal 2018, while earnings-per-share increased 17% for the year.

The Bottom Line

Costco has many qualities that Charlie Munger favors in a business. It has tremendous brand loyalty, durable competitive advantages, and economies of scale. The stock has performed very well over the past several years.

And while right now might not be the best time to buy Costco shares, due to a fairly high stock valuation, the company should continue to grow sales and profits at a high rate for years to come.

Ben Reynolds is CEO of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth stock portfolios for the long run.

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BenReynolds
Costco has many qualities that Charlie Munger favors in a business. It has tremendous brand loyalty, durable competitive advantages, and economies of scale. The stock has performed very well over the past several years.
charlie, munger, loves, costco
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2018-58-17
Wednesday, 17 October 2018 01:58 PM
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