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Add Some Costco to Your Cart

The stock isn't as cheap as the merchandise, but the warehouse giant deserves a premium price.

The next time you're wandering through Costco (symbol COST), picking up everything from socks to steaks, you might think about putting a little Costco stock in your basket, too. The warehouse-store giant is one of the investment world's most consistent winners, and analysts say its shares deserve a place in a long-term portfolio. Perhaps in recognition of Costco’s business stability, traders have gone easy on the stock during the recent market carnage, with the shares falling just 3% since June 18.”

One thing that differentiates Costco from most big-box retailers is that its stores sell only to members. To gain admittance, customers must buy a membership for $55 or $110 a year. In the quarter that ended May 12, the company reported membership fees of $531 million and earnings of $459 million (up an impressive 19% from the same period in 2012). The fees enable Costco to cut prices to a level that just covers costs, and the resulting low prices make for loyal members. The Issaquah, Wash., company brags that 86% of Costco customers worldwide renew their memberships each year — and the percentage is even higher in the U.S., where 449 of Costco's 627 stores are located.

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UBS analyst Jason DeRise says paying a fee for membership also encourages members to become loyal shoppers. Based on the assumption that you'd save about 20% buying at Costco, DeRise figures that "executive" members — those who pay a $110 fee — need to spend $540 annually to recover the cost of their membership. Those paying for $55 memberships need to spend $275 annually. But, in fact, Costco customers spend vastly more — an average of $2,700 per year.

In coming years, the big drivers of Costco's growth are likely to be international expansion and digital sales. Sales at existing locations are expected to rise modestly, but DeRise sees overall revenues doubling over the next decade as Costco adds more stores overseas and as more customers buy over the Internet and via smart phones.

Unfortunately, Costco shares aren't quite as cheap as the merchandise. At $108.65 (as of the June 21 close), they sold for 22 times projected earnings over the next four quarters. That's a high price-earnings ratio for a company that's expected to generate annual profit growth of 13% over the next several years. However, DeRise thinks investors may be underestimating Costco's growth potential, as well as the value of the annuity-like income from those ever-growing membership fees. Besides, the stock almost always sells for a premium P/E. That's because, analysts say, it's tough to find a retailer that generates such consistent earnings growth.

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