Costco Wholesale(NASDAQ: COST) operates around 900 warehouse-style retail stores around the world. Its fiscal 2024 ended on Sept. 1. And during the fiscal year, it generated a whopping $254 billion in total revenue.
This makes Costco one of the largest businesses on the entire planet. Just to put its revenue number into perspective, the company generated as much revenue as Procter & Gamble, Johnson & Johnson, Netflix, and The Coca-Cola Companycombined. Really.
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Costco stocks and sells tons of products. In its sprawling stores, it sells a lot of food and apparel. But it's not limited to this. The company has an e-commerce platform as well. And it also sells everything from appliances to gift cards, gold bars, and more. Basically, if its customers want to buy it, Costco looks for a way to sell it.
Costco's business has an unusual feature that investors need to understand before ever investing. It may be generating north of $250 billion in revenue annually. But less than 2% of this revenue is the key to understanding how the entire thing works.
The key to Costco's entire business model
Costco has one of the biggest businesses in the world from a revenue perspective. But from a profit perspective, it's a different story. The company currently has an operating margin of 3.65%, which is quite low. And this is actually the highest its operating margin has been this millennium, as the chart below shows.
How can Costco boost its profit margins? Well, that's not exactly the goal, which may be surprising to some investors. After all, isn't maximizing profits always the goal? Not necessarily. In fact, the company's competitive advantage is that its customer base is loyal and fanatical. They appreciate the low prices. If management raises prices to increase its profit margins, it risks messing this up.
This is where 2% of Costco's revenue comes in. Shoppers can't just walk into stores from off of the street. To the contrary, Costco stores are for members -- members who pay an annual fee to shop there. Compared to its net sales of $250 billion in its fiscal 2024, its membership fees of $4.8 billion seem minuscule. But they hold the key.
In its fiscal 2024, Costco had total operating income of $9.3 billion. Depending on how one looks at things, its membership fee revenue provided over half of this profit.
In other words, Costco sells tons of products and there are real costs associated with this. The company has to buy merchandise, ship it, stock it, and more. That's all low-margin activity. By contrast, there's no real cost associated with selling a membership, meaning it gets most of its profit from this.
To summarize, Costco attracts customers by having some of the lowest prices around. Management focuses on keeping its prices as low as possible to keep its customers coming back and to attract new customers as well. By delivering on its low-price promise, its customers are willing to pay an annual fee to the company, which supplies most of the profit.
Is Costco a good business for the long term?
When choosing companies to invest in, investors should look for businesses that should stay strong for a long time. To do this, investors must understand how the business works, which is why it's important to understand membership revenue for Costco.
When building an investing thesis for Costco, investors need to determine whether its membership base will stay strong. And the good news for shareholders is that there are a couple of positive indicators in this regard.
Costco just raised its membership prices for the first time in seven years. In its fiscal fourth quarter of 2024, its membership renewal rate for the U.S. and Canada was 92.9%. That's really high and virtually unchanged. It's still early but there's no sign that raising its membership prices is upsetting its members. It's a tangible example of its strength.
Moreover, Costco keeps adding new members. The company had 137 million cardholders at the end of Q4, which was a 7% year-over-year increase.
Finally, about half of Costco's new members are younger than 40 years old. This is younger than the overall average for the company. In short, its customer base is trending younger, which sets it up well for the long term, assuming it retains these members.
In conclusion, investors might believe that Costco's business is rock solid due to the scale of its retail business. However, the strength of its membership base is the real reason investors can expect this business to perform well for years to come.
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Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale and Netflix. The Motley Fool recommends Johnson & Johnson. The Motley Fool has a disclosure policy.
