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Sometimes investors ignore successful stocks for lack of a promising growth profile. Maybe the cash flow seems as well stable, or, with a market capitalization in the tens of billions, a company seems too big for investors to conceive of new growth. Maybe a high potential organization is operating in a low margin industry and paying, God forbid, a dividend, signaling that it may not be in growth mode at all.

Stock market prices can be misleading in this way. Firms with deep competitive advantages and extreme scale are often regularly and quietly rewarded for their dominance. Take retailer Costco (NASDAQ: COST), for example, who has all the strikes listed against him. It’s a massive pillar paying dividends in an industry – wholesale club buying – that generates low single-digit profit margins. In fact, over the past few years, Costco has on average had a paltry operating margin of around 3% and a net profit margin of just 2%.

Yet Costco, with its current market capitalization of $ 153 billion, owns a stock that has outperformed a slew of other “mega-cap” stocks in recent years, many of which are from higher-growth industries:

COST data by YCharts

Note that Costco’s total return has more than doubled that of the S&P 500 Index over the past 10 years – it’s averaging a cool 65% total return per annum over that time period. The stock is currently trading at almost 37 times a year’s earnings.

What do investors like so much about this retail discount? Certainly, the advantage of large-scale enterprise (only Walmart‘s Sam’s Club and BJ Wholesale Club are large enough to provide significant competition) provides support for its premium valuation.

Specifically, while its margins may be anemic, at Costco’s size, low profitability nonetheless translates into huge profits in dollar terms. In the past 12 months, the trading club giant has achieved a turnover of $ 161 billion, which has brought it a net profit of $ 3.7 billion and nearly $ 7 billion operating cash flow.

But perhaps the most compelling reason Costco has appreciated so quickly over the years is its dual promise of huge business benefits and relative safety. For many investors, the company is a proven and defensive consumer staples game that helps to lift the overall risk of the portfolio.

Boxed TV screens and other electronics in a large warehouse club store.

Image source: Getty Images.

The profit and safety premise has certainly played out in 2020, as Costco shares have generated a 19% total return to date to date and are poised to triple the S&P’s 7.5% total return. 500 to date.

In other words, during a pandemic – the ultimate test of consumer goods inventory – Costco has proven itself. The retailer will report on its fourth quarter tax results later this month, but because it releases sales figures monthly, we already have a full picture of the quarter. On the income side, the results seem formidable:

Metric June July August
Total company sales 11,5% 13,2% 13,2%
E-commerce sales 85,8% 75,3% 101,9%
Comparable sales 14,4% 15,8% 14,5%

Data source: Costco Wholesale.

Note that double-digit sales and comparable sales increases have been fueled by an explosion in online sales brought on by COVID-19, an area once seen as Costco’s Achilles heel compared to retail competitors.

Of course, none of this means that Costco is risk-free or that one can’t quibble with recent results. For example, the pandemic surprisingly did not generate as many new members as one might expect. The company’s membership revenue grew only 5% year-over-year in its fiscal third quarter. Compare that with BJ’s Wholesale Club, which improved member income by almost 11% in its last quarter.

Yet even with slower workforce growth, Costco can still reap the benefits provided by its strong balance sheet and supply chain capabilities. For example, CFO Richard Galanti explained in Costco’s most recent results that US sales of high-priced “white goods”, such as home appliances, have grown from $ 50 million four years ago to $ 600 million. million dollars last year. Thanks to COVID-19, white goods sales are on track to cross $ 1 billion this year. Investments like the company’s $ 1 billion purchase of last mile delivery specialist Innovel earlier this year will only increase its ability to generate significant revenue from this market opportunity.

In short, Costco’s business model will provide enough fuel for steady and growing dividends for the foreseeable future. While its 1% dividend yield may seem meager, it stems from a stellar appreciation in stocks. Costco is unlikely to pick up on some of the huge special dividends it has paid in recent years, as my colleague Jeremy Bowman explains, but its regular quarterly dividends should nonetheless provide a nice return: they have grown at a rate of growth. compound annual (CAGR). by 13% over the past 10 years.

Finally, Costco’s low payout ratio of 31% indicates sufficient capacity to maintain its double-digit dividend CAGR. Stability and growth in benign and challenging conditions make Costco an ideal dividend-paying stock, one that income investors should not hesitate to add to their holdings.



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