SKEPTIC’S GUIDE TO INVESTING
Straight Talk for All, Nonsense for None
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Your Hosts - Meet Steve Davenport, CFA and Clem Miller, CFA as they discus the latest in news, markets and investments. They each bring over 25 years in the investment industry to their discussions. Steve brings a domestic stock and quantitative emphasis, Clem has a more fundamental and international perspective. They hope to bring experience, honesty and humility to these podcasts. There are a lot of acronyms and financial terms which confuse more than they help. There are many entertainers versus analysts promoting get rich quick ideas. Let’s cut through the nonsense with straight talk!
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SKEPTIC’S GUIDE TO INVESTING
Costco: Consumer & Investor Appeal Drive Anomalous Valuation
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Do you wonder why a warehouse retailer such as Costco can have a similar valuation to that of AI chip giant NVIDIA? Get ready to uncover the surprising secrets behind Costco's market valuation with Steve Davenport and Clem Miller.
We'll explore how Costco's consistent dividend growth and appeal to middle income consumers have driven its impressive stock performance.
Despite its business model focusing on consumer savings, Costco's stock price raises compelling questions about consumerism, stock valuation, and strategic positioning in a world that has moved well beyond the pandemic.
In this episode, we also dive into the intricate details of Costco's business model. From high employee satisfaction levels compared to Sam's Club and BJ's to the challenges faced by smaller households in bulk buying, we cover it all. Discover whether advanced AI or traditional methods power Costco's efficient inventory management and what institutional investors think about its growth versus current valuations.
Thank you for tuning in, and we look forward to enriching your investing IQ!
Straight Talk for All - Nonsense for None
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Hello and welcome. This is Steve Davenport, with Glenn Miller, and we're here today to talk to you about Costco. It felt a little ironic as we were talking about AI and all that's going on in the world. And I looked at our Morningstar ratings for Nvidia and, given Nvidia's move in the last year, year and a half, it was a multiple of 50 times forward earnings.
Steve Davenport:And then I looked at a three star and then I looked at Costco which has been part of our portfolio and part of a lot of people's for a long time and it's trading at 48 and a half times earnings.
Steve Davenport:And something in me snapped.
Steve Davenport:I don't know how a company that's still selling $1.50 hot dogs and slices of pizza can suddenly go from provider of basic services and goods to competing with the multiples of AI leaders like NVIDIA.
Steve Davenport:Does this mean we should all buy more NVIDIA at 50 times earnings? Does this mean we should sell all our Costco at Costco? Because at 48 and a half times, for a company that makes money from selling you 16 rolls of toilet paper instead of four, it feels to me like there's a. You know, does helping the American consumer consume more lead you to a better company, a better economy, or is there something behind this Costco imagery and Costco experience that we need to understand better? So, Clem, what do you think is behind the desire to be into Costco as a stock and a one rating which, if you remember, one through five, one is overvalued the most, two is slightly overvalued, three is fair value, four is undervalued and then five is most undervalued. So is the marketplace making a mistake here with Costco, or is the marketplace right? And some of these other multiples, some of these other companies with more AI and technology. They're the ones who need to come down.
Clem Miller:So I think that, first of all, in the US industry, among US stocks, you have a wide variety of industries and sectors and there are really good companies in many of these sectors and industries, and Costco is the best in its area of wholesale shopping experiences. They've done really well. On a six-month basis, they've returned 35% versus 15% for the S&P 500. One year, 66% versus 24% for the S&P 500. And over five years, 242% versus 87% for the S&P 500. And of course, those growth numbers, or share price increase numbers, are contributing to what you just mentioned, which is the overvaluation. There's no question about that. But then, obviously, as you're asking yourself, steve, what's leading to this? And I would say a few things.
Clem Miller:First of all, I think that investors are very attracted to Costco being a dividend growth company, and so that's attracting a lot of investor interest. So over the last five years, costco has generated dividend growth of an average of 12.33% per year, which is really strong. So, annualized over five years, 12.33%. And they've paid a dividend every year for the last 19 years. And they've paid a dividend every year for the last 19 years. So they have had dividends every year for the last 19 years. So that's pretty strong they have.
Clem Miller:The second thing I would mention that I think is driving this is that is that Costco has a reputation, or if you look at their prices you know they are actually a. They actually produce a narrower number of items at higher price margins than do Sam's club or BJ's Wholesalers. So you can look at that. We all think of I mean most of us think of the three of them as being similar, but Costco actually has an edge in appealing to a higher class, so to speak, within that level of consumer class, so to speak, within that level of consumer, so slightly more wealthy I wouldn't say necessarily wealthy, but slightly less poor individuals will go to Costco rather than to Walmart or BJ's.
Steve Davenport:Well, I joke with my kids about you know, I want to go to Costco so I can become a millionaire. I don't know how having those extra 12 rolls of toilet paper are going to make me a millionaire, because I'd have to have a pretty good inventory system to make sure, but it feels to me like Costco is the essence of US consumerism. We believe that it's good to have four rolls of toilet paper, it's spectacular to have 16. And I agree that you should have to have some trade-off. But when I look at consumer prices and I look at individuals, most people aren't getting the price they think they're getting for that Costco brand because of slippage. Right, everybody has some slippage, everybody throws out some soup, everybody has some stuff that doesn't get utilized as you think it's going to, because it doesn't. You don't save as much as you think you're saving, and so I guess I find it amazing that a brand can maintain its competitiveness and its margins even though we know we probably don't need all the stuff we have, right?
Steve Davenport:I was most shocked about the multiples, because we're not heading into COVID, we're not heading into a period where everybody is stocking up on wipes and bleach. We're in a period where everybody is stepping away and going outside and doing more things and traveling. And guess what? Costco is getting more involved in travel, getting more involved in other parts of their business and it's just amazing to me how they can adjust. And I don't want to say it's an artificial world and you've got to live in it, but the world around it, it doesn't differ from its focus. It focuses on doing things for consumers that make their experience better, and people will pay for that. And I guess I just wonder is it a little strange that a company that is so much about value, its stock can be so much overdone in terms of the value it delivers?
Clem Miller:Yeah, I would call it a true anomaly, steve, to look at a company like Costco and see it as equally valued as, say, an NVIDIA, and actually much more highly valued than some of the other magnificent seven stocks. But if you look at so look at.
Steve Davenport:AlpilioMH, I mean ultimate luxury brand, but you know, if you look at From a perspective of how we consume and how we view things, no, and just like this, I find that Costco is kind of getting margin on these items that are higher. Have the consumers turned off the I'm evaluating Costco button and said I just love the brand and I'm going to buy it and I'll pay whatever, even if it's a higher margin, because I love the concept?
Clem Miller:I do think there's a lot of that.
Steve Davenport:But I thought we were thoughtful economic animals. I thought we made decisions that were more rational and more you know.
Clem Miller:It comes back to the. It's almost like the Charlie Munger thing and I know Charlie Munger at times is like Costco. The Charlie Munger thing about invest in what you know right and US investors know Costco and they know it for better rather than for worse, and so they will invest in Costco, right.
Steve Davenport:Do you know if the retail institutional is higher retail than Costco as an investment? I know you look at how much it's shorted, but do you look at how much institutional ownership sometimes in these names?
Clem Miller:I don't as a matter of money, yeah, I don't as a matter of a regular course in my analysis, but yeah, I mean that's that's something we can look at my analysis. But yeah, I mean that's something we can look at and I could certainly look at it later in the podcast if you talk for a while. But you just mentioned a couple of other things that I think are worth pointing out, which is well. One is the short interest ratio, which is the short interest as a percentage of float for the company, and actually it's pretty good for Costco 1.44%, which means that a lot of short sellers are kind of ignoring it. Now let's compare that to BJ's Wholesaler BJ's wholesaler and BJ's has an incredibly high 9.27% short interest ratios. That indicates that a lot of short sellers are hanging out waiting to exercise when the stock goes down.
Clem Miller:I'll point out another thing too, steve, and I think this goes to impressions that consumers may have about Costco relative to the others. The employees at Costco tend range for very satisfied, so they're almost very satisfied their employees, and if you compare that to Sam's Club, that's at 3.4 and BJ's is at 3.00. So employees are much happier at Costco than they are at at Sam's or BJ's.
Steve Davenport:Do they have a higher percentage off or discount for employees?
Clem Miller:Maybe that's it, I don't know.
Steve Davenport:I mean I have trouble. It's the two of us now at home and so we don't have one of our kids over or we don't have guests coming. It's hard to buy remade food because we're just not going to get through. And I just kind of look at myself and say, ok, you know, maybe I'm not being frugal enough or maybe I'm not being, you know, saving us and having it three times instead of two times. And I just find the Costco conundrum a little bit hard to take.
Steve Davenport:And how does it? Is it related to AI? Are they becoming to me? They are always an expert in analyzing inventory and analyzing when to bring something in on a Thursday, and that space would be freed up by Saturday. And here's what we're going to do with follow up. I mean, they move those blocks around the floor and they know what they're doing, they know how things are running and how things are being consumed. And I just think that is it just inventory management, which has been around for 40 years, or is there something new in the way that Costco is managing the business?
Clem Miller:Well, I think there's. I mean just I think nothing has changed really on the management of the business inherently. But I will say that they are continuing to expand. They're expanding overseas and that always helps increase sales and they're also moving more into online. So that helps on their sales as well.
Clem Miller:So if you look at annualized revenue growth over the last three years, it's been 12%, which is pretty high. So double digit annualized revenue growth over the last three years it's been 12%, which is pretty high. So double digit annualized revenue growth. Which you compare that to Sam's or to looking at Walmart, which incorporates Sam's as well as Walmart, that's 5% revenue growth over the last three years, and BJ's, which is 9%. So 12% is quite a bit higher than those two. And earnings growth 16% earnings growth the last three years annualized for Costco versus 8% for BJ's and about the same 17% for Walmart slash Sam's Club. So yeah, I mean Costco is generally a faster growing company than these other two and I'd say, if you look at a wide range of companies, 12% annualized revenue growth over three years is pretty strong. So that's a very fast growing, fast growing company. It's got it's profitable, although not that profitable. It's not Nvidia profitable, but it's.
Steve Davenport:Yeah, I mean, I looked up the institutional holding. What do you think the number is? Oh, I don't know 72%.
Clem Miller:Oh, okay, that's good.
Steve Davenport:I mean, I don't know why, glenn, but I think there's going to be some foibles. When I see something mispriced, I'm going to say, boy, the smart institutional people wouldn't be overpaying for this. But here we are, and I'd say that 72 is a pretty high percentage of institutional ownership. Yeah, and it's you know. So what do you think the Intellectia Investment Group, the intellectual investor, is looking at here that they see they have to have it?
Clem Miller:The institutional investor right.
Steve Davenport:I mean as opposed to I'm making the presumption that the institutional is also intelligent, which you and I can probably debate back and forth as to-.
Clem Miller:Right? Well, I'd like to think I'm more intelligent than many institutional investors.
Steve Davenport:I'm not sure I can get a hundred percent of everybody in this house.
Clem Miller:But you know what do they see? You know it makes you wonder whether institutional investors are less value conscious than maybe should be. That maybe would be the case if you just look at sort of the academic literature. You know the academic literature would suggest that value is a very important consideration and that, you know, buying cheap stocks or cheap profitable stocks or cheap stocks at an inflection point of some kind you know, is the way to go.
Clem Miller:That's sort of the value philosophy and it seems here like institutional investors are sticking with those stocks that are growing the fastest, even if they're at a very high, perhaps astronomical, right, almost, you know, rate of, you know PE ratio or evaluation. It's like it's like this you know, when we look, steve, when the data that we look at when it comes to valuations are typically forward one year, typically for PE ratio, I think a lot of folks are a lot of smart institutional investors are saying, ah, that's not the relevant measure of value it really should be. How is this company going to grow over the next five years? And are they going to grow into that valuation? I mean, it may be 50 right now, but is it going to be 25 in five years or 20 in five years, and so I think they're looking at that and saying that some highly valued companies you know are going to grow into that.
Steve Davenport:not all of them, uh, but I guess I even see, even when you talk about snowflake and you talk about companies that are on the cutting edge of biotech yeah but when we're talking about a company that I mean people have been buying and selling milk and ice cream for quite a few years, and so it feels to me like how are you able to extract more from the same low that was sold two years ago, three years ago, five years ago? It feels like if you were going to pick an industry where somebody would be able to take what they're doing and replicate it or do it better or do something as a competitor like they don't seem to be having more competition. They seem to be taking more competition. So it feels to me something like we keep looking for this intellectual reason why these AI stocks are worth more, reason why these AI stocks are worth more. Yet we have a very simple company right in front of us that we have trouble with determining. How. Why is it worth 48 times?
Clem Miller:Yeah, that's why this conundrum about valuation is one of the reasons I look at short interest, because valuation may not mean a hell of beans if short interest is actually quite low. That low short interest indicates that not a lot of short sellers are looking at the high valuation as being a potential problem. I do see companies out there that have high short interest ratios and have high valuations, and so those are ones that I'd want to stay away from, and so you know. Those are ones that I'd want to stay away from, and so you know. It makes me wonder if you know at least some institutional investors are also monitoring that short interest, that short interest ratio.
Steve Davenport:Yeah, I mean I don't think I'm going to run away from the stock because it still runs so well and still get a lot of things going for it. But I also think there's a certain mom and popness of yes, we're going to keep our $1.50 hot dogs and I don't know how many hot dogs they make and I don't know how much the true value of the hot dog is and whether there is a. Are they losing 50 cents a hot dog? I think they've got a lot of other things they do well, but it's interesting to me that they would still focus on that as a reminder to their customers and their consumers that they still care about prices and how it affects you. They still care about inflation, and to me it's kind of like Sam Walton. You can feel like he's put an arm around his shoulder and say you come shop with me and I'm going to take care of you, and I think it's kind of old school. But in a world of AI, can something as old school as that be able to drive sophisticated institutional investors?
Clem Miller:Right. I think that kind of business model actually works and I think it actually works well in an environment where you've had higher inflation, because I think inflation is an issue that is sticky right in people's minds. It's psychological sticky. Psychologically sticky in the sense that you know inflation is coming down, right, the rate of inflation is coming down, which is the rate and the rate of prices. I don't think a lot of people actually think about prices that way. I think they think about prices as well. Is that price higher than what it was a year ago? And it still is.
Steve Davenport:I mean my point was so excited about eggs coming down. You know, oh, look at these eggs. They used to be outrageous and now they're only semi-outrageous and I'm like we don't eat that many eggs. Like I want to figure out where the you know where the big money is. Is it in the meat? Is it in the? You touch those three prices and all of a sudden all hell breaks loose if it goes too much. And you look at them as a percent of our overall economic income and it's minimal, but psychologically it has a big impact.
Clem Miller:Then you've got this other Costco gimmick of the gold bullion bars. Have you heard about that one? No, I think it's a gimmick. It's obviously a gimmick, but I think, I mean, I think it's a gimmick. I mean it's obviously a gimmick, but I think psychologically it it, it puts in people's minds that Costco is not a Sam's club and is not a BJ's. In fact, I think it puts in people's minds that it's not even a target right. Even though target's a step above, you don't see target selling gold bullion. So it's kind of a curious thing that I think appeals to this certain imagery of Costco being price conscious, because in people's minds they think about gold and in many investors' minds they think about gold as a way to protect against inflation.
Steve Davenport:Yeah, man, I think this goes back to that point. Like somebody on a survey at Schwab or someone else said how many people consider themselves middle class and 70% of the country does, and 70% of us will all be middle class. I don't think that's probably realistic, but that I don't know that puritanistic. You know US value orientation where you you know you take those potatoes out of the ground and you clean them off and you know you put stuff in the barn for the winter. Right in the barn for the winter, right, it feels like. For as an advanced economy as we have, there's still some basic, what I'll call Puritan Americana values that most people want to say. Oh, I'm not foolish with my money, I'm not doing things that don't make. I shop at Costco. I do that. Here's all my supplies for. I only buy used, I only buy used cars, I only buy used cars. I mean, we all want to be in that group, don't we that are considered fiscally wise. Some people call me cheap, but I like to say it's more frugal.
Clem Miller:Well, you know, you pick what you. You pick those things where you want to spend your money, right.
Steve Davenport:Right. So I'm not out there buying, we hide from it and other times we glory right.
Clem Miller:I mean, I never buy a new car, I always buy a few years old car, but on the other hand I'll take month-long foreign trips, so it's all relative, right, right.
Steve Davenport:All right Is there anything else you want to say about Costco?
Clem Miller:No, I think that's it. We've covered a lot of territory there, all right.
Steve Davenport:Thank you all listeners to Skeptic's Guide and if you could do us a real favor, give us a like, share, share the link to the website with your friends. We're trying to bring what we think is honest information to individuals to help them improve their investing IQ, and we appreciate all the listeners and we appreciate the effort and we look forward to. Our next podcast is going to be with a special guest, dan Solon. Dan has a book out, the Field Guide for Millennials, and he's trying to help individuals starting off in life to find the way forward with financial well-being, and we want to help them do that as well. So thanks again and have a good weekend. Bye.
