Why I Paid a Premium for Costco

I owned shares in Costco (symbol COST, $186) in the early 1990s thanks to its merger with Price Co., a San Diego, Calif., warehouse store in which I held shares. At a time when the rest of the stock market was going gangbusters, my investment in Costco went nowhere. After two whole years, my patience was exhausted. I sold.

Naturally, that was the catalyst needed to break the stock out of its funk. I've wanted to repurchase Costco shares practically ever since, but I've been deterred by the math. Based on my favorite formula–buy a stock when the price-earnings ratio is less than the sum of the earnings-growth rate and the dividend yield–Costco shares were perpetually too expensive. Even in the midst of the 2008 financial crisis, when shares of other companies could be had for a song, Costco was a touch above my target price.

So I waited. And waited. Finally, when the stock market swooned in early February, I bought. Costco shares were still too expensive based on my formula. But because that seems to be the norm, I decided it wouldn't dissuade me from buying a company I really wanted to own.

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Everything about its business impresses me. Let's start with the fact that I have been a Costco shopper for 28 years (it says so on my membership card). I've always been a fan of Costco quality, selection and prices, and part of what sold me on Costco as an investment is that I find myself buying more–and more expensive–products from the retailer every year.

More than paper towels. I still fill my pantry at Costco warehouses, of course. But because of Costco's liberal return policies, I find myself buying big-ticket items online that I would never buy sight unseen from another company. I tested big-ticket purchases when I moved to a new house that had a game room. Costco.com was advertising a billiards-table package that appeared to be $500 to $1,000 cheaper than anything comparable. But it was still expensive. I wanted to see and touch it before spending so much money. I called customer service to ask whether I could find it in a warehouse. The representative said no but, sensing my concern, reminded me that I could return it for any reason. "I can't put a billiard table in my car and drive it back to the warehouse," I objected. "We'll pick it up at no charge," the rep said. Two weeks later, Costco delivery agents were setting up the table in my game room. It's not going back.

Next was a leather living room set. Then outdoor furniture. Soon, I was buying cars through Costco's auto-buying program and using the company's affiliates to insure my house and put solar panels on the roof. I went to Hawaii through Costco travel.

But it isn't just the shopping that has sold me on the stock. I also love how Costco runs its business, starting with the fact that the company promotes from within. Current chief executive W. Craig Jelinek rose through the ranks, spending 20 years in various positions in the company's warehouses before joining senior management. Perhaps because top officers know what it's like to work in the warehouses, warehouse employees are paid well and garner generous benefits. Being a good employer allows the company to hire and retain exceptional employees, which makes the business run more smoothly.

Still, even though I'm a Costco fan, the cheapskate in me flinches a bit at its stock price. At $183 a share, I paid almost 25 times estimated earnings for a company that's expected to increase profits at an annual pace of 17% in the fiscal year that ends in September and pays a paltry dividend (the stock yields 1.1%). According to my formula, I shouldn't have paid more than 17 times earnings. But the stock is already up about $3 per share since I bought in. It may prove to be as big a bargain as everything else I buy at Costco.