Costco Wholesale (NASDAQ:COST) is Surprisingly Good at Delivering Returns

By
Goran Damchevski
Published
August 26, 2021
NasdaqGS:COST
Source: Shutterstock

Costco Wholesale (NASDAQ:COST), has been around since 1976, and the company delivered a 1-year total return of 35.6%. That is quite impressive for this mature, US$200 billion Market Cap Company. Costco is the 3rd largest retailer with 809 warehouses worldwide and US$186b trailing twelve months revenue.

The company is continuously curating its product portfolio and has recently included multiple new brands to its warehouses:

new-brands
NasdaqGS:COST New Brands in Portfolio 26th 2021

In this analysis, we will look at the efficacy of the business at generating returns. There are multiple return measures, and when looking at businesses that employ both debt and equity, we feel that ROCE is a great place to start.

Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Businesses that reinvest tend to grow, and those that manage to get a high return are definitely doing a few things right.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Costco Wholesale:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.24 = US$7.0b ÷ (US$57b - US$28b) (Based on the trailing twelve months to May 2021).

Thus, Costco Wholesale has an ROCE of 24%.

In absolute terms that's a great return and it's even better than the Consumer Retailing industry average of 8.0%.

View our latest analysis for Costco Wholesale

roce
NasdaqGS:COST Return on Capital Employed August 26th 2021

In the above chart we have measured Costco Wholesale's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Costco Wholesale.

What Can We Tell From Costco Wholesale's ROCE Trend?

We'd be pretty happy with returns on capital like Costco Wholesale. Over the past five years, ROCE has remained relatively flat at around 24% and the business has deployed 73% more capital into its operations.

With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return.

Potential Risks

Costco Wholesale's current liabilities are still rather high, at 49% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The company is focused on efficiently running its warehouses, this is great, but it seems that there is something preventing it from embracing digitalization - similarly to Target's (NYSE:TGT) example. Perhaps management has a different mindset, but it would be great to see some bold moves and propositions for the future.

The leadership structure is also a concern. While it is evident that they have massive experience under their belt, it does seem like the company may benefit from a fresh perspective.

Innovation is necessary, whether it is an advanced ERP system, machine learning to optimize the supply chain, forecasting tools for estimating consumer behavior, or just a fresh web store and application where consumers can become closer to the retailer. If Costco does not step up, it will soon discover that it is far behind the competition and will pay the price.

Conclusion

Costco Wholesale has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. The company has an ROCE of 24%, implying a very effective return both on debt and equity financing.

The stock has done incredibly well with a 212% return over the last five years, so long term investors are no doubt ecstatic with that result.

Costco has some qualitative risks, such as experienced management but with an older mindset. The company could probably do more to innovate and bring customers closer via digitalization.

If you'd like to know about the risks facing Costco Wholesale, we've discovered 2 warning signs that you should be aware of.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

Simply Wall St analyst Goran Damchevski and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com

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