Tag Archives: SHOP

5 Stocks That Could Be the Next Amazon

Amazon.com, Inc. (NASDAQ:AMZN) has been one of the more impressive stocks of the past 25 years. In fact, AMZN now has returned nearly 100,000% from its IPO price of $18 ($1.50 adjusted for the company’s subsequent stock splits).

A large part of the returns have come from two factors. First, Amazon has vastly expanded its reach. What originally was just an online bookseller now has its hands in everything from cloud computing to online media to groceries. And its shadow is even larger. A potential entry by Amazon has rattled pharmacy stocks and medical distributors, among others.

Secondly, as a stock, AMZN has managed the feat of keeping a growth stock valuation for over two decades. I’ve long argued that investors can’t focus solely on the company’s high P/E ratio to value Amazon stock. But however wise an investor might the current multiple is, the market has assigned a substantial premium to AMZN stock for over 20 years now.

It’s an impressive combination — and one that’s likely impossible, or close, to duplicate. But these five stocks have the potential to at least replicate parts of the Amazon formula. All five have years, if not decades, of growth ahead. New market opportunities abound. And while I’m not predicting that any will rise 100,000% — or 1,000% — these five stocks do have the potential for impressive long-term gains.

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5 Stocks That Could Be the Next Amazon Stock: JD.com (JD) 5 Stocks That Could Be the Next Amazon Stock: JD.com (JD)Source: Daniel Cukier via Flickr

JD.com Inc(ADR) (NASDAQ:JD) is the company closest to following Amazon’s model. While rival Alibaba Group Holdings Ltd (NYSE:BABA) gets most of the attention, it’s JD.com that truly should be called the “Amazon of China,” as Will Healy pointed out in December.

Like Amazon (and unlike Alibaba), JD.com holds inventory and is investing in a cutting-edge supply chain. It, too, is expanding into grocery, like Amazon did with its acquisition of Whole Foods Market. A partnership with Walmart Inc (NYSE:WMT) should further help its off-line ambitions. JD.com even is cautiously entering the finance industry.

That ability to both provide best-in-class logistics and satisfy a wide range of customer needs is what has made Amazon a success. And while JD may not rise to the scale of Amazon, at its current valuation it doesn’t have to. After a recent pullback, JD trades at less than 26x forward EPS. That’s despite 40% revenue growth in 2017, and expectations for a 30% increase in 2018.

And it sets up a scenario where JD stock could — if sentiment finally turns in its favor for good — appreciate for years, thanks to both strong bottom-line growth and an expanding multiple from optimistic investors.

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5 Stocks That Could Be the Next Amazon Stock: Square (SQ) 5 Stocks That Could Be the Next Amazon Stock: Square (SQ)Source: Chris Harrison via Flickr (Modified)

Admittedly, I personally am not the biggest fan of Square Inc (NYSE:SQ) stock. I like Square as a company, but I’ve questioned just how much growth is priced into SQ already.

Of course, skeptics have done little to dent the steady rise in AMZN stock. And valuation aside, there’s a clear case for Square to follow an Amazon-like expansion of its business. Back in January, Instinet analyst Dan Dolev compared SQ to AMZN and Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG), citing its ability to expand from its current payment-processing base:

In 10 years, Square is likely to be a very different company helped by accelerating share gains from payment peers and relentless disruption of services like payroll and human resources.

Just as Amazon used books to expand into e-commerce, and then e-commerce to expand into other areas, Square can do the same with its payment business. The small business space is ripe for disruption, as Dolev points out. Integrating payments into payroll, HR, and other offerings would dramatically expand Square’s addressable market – and lead to a potential decade or more of exceptional growth.

Again, I do question whether that growth is priced in, with SQ trading at ~about 12x the company’s 2018 guidance for “adjusted” revenue. But if — again, like AMZN — Square stock can combine a high multiple with consistent, impressive, expansion, it has the path to create substantial value for shareholders over the next five to 10 years.

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5 Stocks That Could Be the Next Amazon Stock: Shopify (SHOP) 5 Stocks That Could Be the Next Amazon Stock: Shopify (SHOP)Source: Shopify via Flickr

E-commerce provider Shopify Inc (NYSE:SHOP) probably doesn’t have quite the same opportunity for expansion as Square. And it too has a hefty valuation, along with a continuing bear raid from short seller Citron Research.

But I’ve remained bullish on SHOP stock — and here, too, a recent pullback presents a buying opportunity. Shopify is dominant in its market of offering turnkey e-commerce services to small businesses. That’s exactly where consumer preferences are headed: small and unique over large and bland. And because of offerings like Shopify (and Amazon Web Services), those small to mid-sized businesses can compete with the giants.

Meanwhile, Shopify does have the potential to expand its reach. Just 29% of revenue comes from overseas, a proportion that should grow over time. It’s moving toward capturing larger customers as well through its “Plus” program, picking up Ford Motor Company (NYSE:F) as one key client. The development of an ecosystem for suppliers and the addition of new technologies (like virtual reality) give Shopify the ability to offer more value to customers — and to take more revenue for itself.

Like SQ, SHOP is dearly priced. But both companies have an opportunity to grow into their valuations. And given long runways for Shopify’s adjacent markets, it should keep a high multiple for some to come. As a stock, if not quite as a company, SHOP has a real chance to follow the AMZN formula for long-term upside.

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5 Stocks That Could Be the Next Amazon Stock: Roku (ROKU) 5 Stocks That Could Be the Next Amazon Stock: Roku (ROKU)Source: Shutterstock

Roku Inc (NASDAQ:ROKU) might have the best chance of any company in the U.S. market to follow Amazon’s strategic playbook. The ROKU stock price is a concern: I wasn’t thrilled about the price after a huge post-earnings gain back in November, and even near a five-month low ROKU isn’t close to cheap.

But — perhaps even moreso than Square — Roku now isn’t what Roku is going to be in ten years. The hardware business is a loss leader, but one that allows Roku to serve as the gateway to content for millions of customers. As the company pointed out after Q4 earnings, it’s already the third-largest distributor of content in the U.S. The Roku Channel is seeing increasing viewership. The company offers pinpoint targeting of advertisements — without the messy data problems afflicting Facebook, Inc. (NASDAQ:FB).

Roku is becoming increasingly embedded in TVs, though a deal between Amazon and Best Buy Co (NYSE:BBY) raised some fears about those software efforts going forward. It has a plan to roll out home entertainment offerings like speakers and soundbars, creating a long-sought integrated experience. It could even, as it grows, look to develop or acquire content itself, positioning Roku not as just a conduit to Netflix, Inc. (NASDAQ:NFLX) but a rival.

The bull case for Roku stock is that its players are like Amazon’s books — a way to garner customers and get a foot in the door of the exceedingly valuable media business. What Roku does now that it has entered will determine the fact of ROKU stock. But the amount of options and a reasonable valuation (Roku’s market cap is barely $3 billion) mean that betting on its strategy could be a lucrative play.

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5 Stocks That Could Be the Next Amazon Stock: Nvidia NVIDIA Corporation Stock (NVDA) Won't Stay Down Long After Shocking Analysts Source: Shutterstock

In the context of the stocks chosen here, Nvidia Corporation (NASDAQ:NVDA) doesn’t seem particularly expensive. But in the context of the traditionally cyclical — and low-multiple — semiconductor space, a ~34x multiple to 2018 consensus EPS estimates, even backing out net cash, is awfully pricy.

And with NVDA up a whopping 1,550% in just the past five years, investors would be forgiven for thinking the run might come to an end. Indeed, NVDA stock hasn’t really moved over the past four-plus months.

But the huge amount of secular tailwinds behind Nvidia suggest that the company should be able to drive torrid growth for years to come – and to maintain a multiple that looks rather high on a historical basis. The company’s automotive business gets a fair amount of press, given its potential applications to autonomous driving. But that growth likely won’t come in earnest until the next decade.

It’s the datacenter business that looks most appealing in the near term. Revenue in that category more than doubled in 2017. Thanks to cloud providers like AWS, demand should continue for years to come. And with Nvidia taking share from Intel Corporation (NASDAQ:INTC), its growth should be even better than that of the market. High-end gaming demand should rise, and virtual reality will add another tailwind there.

Unlike, say, Roku (or early-days Amazon), Nvidia’s growth opportunities are mostly known. But at $223, even with a high multiple, they’re not fully priced in. I still see an easy path to $250 for NVDA in the near term. Longer-term, its presence (if not outright dominance) of key markets should lead Nvidia stock to double, at least.

As of this writing, Vince Martin has no positions in any sec

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Hot Safest Stocks To Invest In Right Now: RadiSys Corporation(RSYS)

Advisors’ Opinion:

  • [By Lisa Levin]

    RadiSys Corporation (NASDAQ: RSYS) was down, falling around 18 percent to $2.97 after the company lowered its sales forecast for the second quarter. The company now expects Q2 sales of $35 million, versus earlier outlook of $41 million to $47 million.

  • [By Lisa Levin]

    RadiSys Corporation (NASDAQ: RSYS) was down, falling around 18 percent to $2.95 after the company lowered its sales forecast for the second quarter. The company now expects Q2 sales of $35 million, versus earlier outlook of $41 million to $47 million.

Hot Safest Stocks To Invest In Right Now: Shopify Inc.(SHOP)

Advisors’ Opinion:

  • [By Brian Stoffel]

    That’s why Shopify (NYSE:SHOP) is in such a sweet spot. The company provides a platform for small and medium-sized businesses to create an online presence and manage all of the logistics of e-commerce. Even largerplayers like Tesla, Budweiser, and Red Bull count themselves as Shopify customers.

  • [By John Ballard]

    Less than 10% of retail sales in the U.S. take place online, and the worldwide retail market is estimated to be well over $20 trillion.These numbers spell big opportunity for top e-commerce companies like PayPal Holdings (NASDAQ:PYPL) and Shopify (NYSE:SHOP).

  • [By WWW.FOOL.COM]

    Shopify(NYSE:SHOP)stock has been on a tear, rocketing up over 180% since the company went public in May of 2015. The company’s business model is pretty simple: Sign up merchants, charge merchants to use its platform, help merchants sell stuff, and take a small percentage from each sale. Then, rinse and repeat at alarger scale with more profitability. Shopify is executing this strategy extremely well, posting strong third quarter 2016 results with record growth in total merchants, sales volume, and revenue.

Hot Safest Stocks To Invest In Right Now: Compass Diversified Holdings(CODI)

Advisors’ Opinion:

  • [By WWW.MONEYSHOW.COM]

    Compass Diversified Holdings (CODI) seeks to invest in manufacturing, distribution, consumer products, and business services sectors.

    One thing I like about Compass is its strict definitions of its acquisition strategy. They have a six-step process of identifying companies to acquire that reads simply, but has lead to astounding success.

Hot Safest Stocks To Invest In Right Now: Denison Mine Corp(DNN)

Advisors’ Opinion:

  • [By Jim Robertson]

    Last Thursday, small cap uranium mining stock Denison Mines Corp (NYSEAMERICAN: DNN), which is alsofocused on the Athabasca Basin of Saskatchewan, reported 2017 earnings and gave its outlook for 2018 with the outlook coming with extensive commentary about the uranium market and Athabasca. David Cates, the President and CEO of Denison Mines Corp,gave the following commentary:

Hot Tech Stocks For 2018

Spotify just added a new platform for its streaming services ahead of the Spotify IPO date…

According to an Aug. 4 TechCrunchreport, Microsoft Corp. (Nasdaq: MSFT) will add a Spotify app to the new Xbox One X, slated to debut this November.

Spotify has been available on rival PlayStation 4 since 2015, so why has it taken so long for Microsoft to add an app for the streaming service to its network?

MSFT offers its own music service, Groove Music, which launched in 2012.

According to TechCrunch, keeping Spotify out of its platform may not have significantly contributed to Grooves user growth. It could also cost Microsoft sales if users are deciding between an Xbox and a PlayStation.

Hot Tech Stocks For 2018: IPG Photonics Corporation(IPGP)

Advisors’ Opinion:

  • [By Dan Caplinger]

    Monday began on a down note for the stock market, as the Dow Jones Industrials fell back down below the 20,000 level. Major market benchmarks finished with losses of 0.6% to 0.8%, and some market commentators attributed the declines to nervousness about the Trump administration’s actions to clamp down on immigration. Others noted that the latest reading of U.S. economic growth showed a 1.9% rise in gross domestic product for the fourth quarter, finishing the year with an overall GDP increase of just 1.6%, down a full percentage point from 2015’s growth. Despite the overall sullen mood in the market, some stocks gained ground, and GoPro (NASDAQ:GPRO), Movado Group (NYSE:MOV), and IPG Photonics (NASDAQ:IPGP) were among the best performers on the day. Below, we’ll look more closely at these stocks to tell you why they did so well.

Hot Tech Stocks For 2018: Shopify Inc.(SHOP)

Advisors’ Opinion:

  • [By John Ballard]

    Less than 10% of retail sales in the U.S. take place online, and the worldwide retail market is estimated to be well over $20 trillion.These numbers spell big opportunity for top e-commerce companies like PayPal Holdings (NASDAQ:PYPL) and Shopify (NYSE:SHOP).

  • [By ]

    Shopify (NYSE: SHOP) is an ecommerce platform and hosting company providing the websites and tools for small businesses. The company and its customers might not have the financial capital for access to fast lanes in a post-neutral internet.

  • [By Brian Withers]

    If investors want to tap into the growing trend of e-commerce and diversify their portfolio beyond Amazon, Shopify (NYSE:SHOP) and Etsy (NASDAQ:ETSY) make the shortlist. Shopify is more a pick-and-shovelplay, as the company hasbuilt a powerful back office platform that essentially enables entrepreneursto run an e-commerce business from their phone. Etsy is a pure play marketplace that focuses on serving the creative entrepreneur. These two companies had similar revenue in 2016, were both started in almost the same year (Etsy 2005, Shopify 2006), and are in the business of helping product-selling entrepreneurs connect to buyers online. Let’s take a deeper dive into these two companies and see which is the better buy.

Hot Tech Stocks For 2018: Mitel Networks Corporation(MITL)

Advisors’ Opinion:

  • [By Lisa Levin]

    ShoreTel Inc (NASDAQ: SHOR) shares shot up 28 percent to $7.47. Mitel Networks Corp (NASDAQ: MITL) announced plans to acquire Shortel for $7.50 per share in cash.

Hot Tech Stocks For 2018: Mastercard Incorporated(MA)

Advisors’ Opinion:

  • [By Dan Caplinger]

    Visa Inc. (NYSE:V) and MasterCard (NYSE:MA) aren’t the only two players in the credit card and electronic payments space, but they are the biggest and best-known. Both Visa and MasterCard have extended their reach across the globe, and both have high expectations in their trajectories for future growth. Yet after a big push in the stock market that has sent both of these financial stocks to all-time highs, investors need to know which of the two leaders in the card industry is more deserving of their attention. Let’s take a closer look at Visa and MasterCard, comparing them using several different metrics to see which company’s shares are the better buy.

  • [By Brian Feroldi, Dan Caplinger, Rich Duprey, Jason Hall, and Jordan Wathen]

    In order to point you in the right direction, we asked a team of Fools to highlight a dividend stock that they feel is a great stock for a beginner. Read on to see why they picked AT&T (NYSE:T),Apple (NASDAQ:AAPL),Anheuser-Busch InBev(NYSE:BUD), Mastercard(NYSE:MA), andJPMorgan Chase(NYSE:JPM).

  • [By WWW.GURUFOCUS.COM]

    For the details of Night Owl Capital Management, LLC’s stock buys and sells, go to www.gurufocus.com/StockBuy.php?GuruName=Night+Owl+Capital+Management%2C+LLC

    These are the top 5 holdings of Night Owl Capital Management, LLCVisa Inc (V) – 231,674 shares, 10.84% of the total portfolio. Shares reduced by 5.42%Mastercard Inc (MA) – 167,458 shares, 9.92% of the total portfolio. Shares reduced by 5.37%Alphabet Inc (GOOG) – 18,613 shares, 8.13% of the total portfolio. Shares reduced by 4.05%Amazon.com Inc (AMZN) – 15,674 shares, 7.32% of the total portfolio. Shares reduced by 3.17%The Priceline Group Inc (PCLN) – 6,970 shares,

Costco – Why The Market Might Be Right

I think we can all agree the market can at times be, shall we say myopic? But in the long run, the market has a great way of separating the winners from the losers. It is the summation of all thoughts, fears, demand, supply, and even a bit of greed. The market is the consummate weighing machine of not the past, but the prospects of a company.

So, when I see Costco (NASDAQ: COST) trading at all-time highs, with a large expansion in its market multiple its easy to dismiss this as Ahh the market is overvaluing this company and to be skeptical. I was cautious on the stock at $158. But it is more prudent to try to understand just why the market seems so in love with Costco lately and why I had it so wrong.

Chart
COST data by YCharts

Nice chart lately. You can see the noise effects of Amazons (NASDAQ: AMZN) foray into Whole Foods. The pros/cons of that purchase have been repeatedly covered here on Seeking Alpha. A 2nd chart below, with a more expanded time frame, shows Costcos Trailing Twelve Month (TTM) P/E Ratio. Note, the stock is not that far above its historical average P/E multiple.

Chart
COST data by YCharts

The value folks are screaming Sell! and the long-term holders are simply saying Yawn. If the short argument is that the stock is overvalued that is a bit of a stretch, but you could make that case. But how overvalued? 20-30 points or so? Not a compelling risk-reward. Shorting stocks on valuation is almost always the wrong approach.

Sometimes its just as simple as this, the best stocks always seem overvalued. But in Costcos case, Im going to outline 4 reasons why the market might have this one right. I progress from the rather obvious point 1 to the bit more obscure point 4.

Point 1 – Solid management and a long-term, laser-like focus on its customers and needs.

No new revelations here, but Costcos management is well regarded. Employees are treated rather well for a retailer. 88% of Costco Employees have company-sponsored healthcare. Coincidentally, 88% of Costco employees think they are Fairly Paid. A loyal workforce and low turnover have always been a Costco staple. Not an earth-shattering observation I know, but still refreshing to see.

Point 2 The membership program, and the effect on gross margins.

Of course, we all know that Costco has a membership fee. This allows the company to sell products at a razor-thin margin. The company’s yearly gross margins, dating back to 2008, can be seen here. Lately, margins have been about 13.3%. Yes, that includes its membership fees. But the world is changing. Here is where Amazon might have helped Costco. It is now very well engrained into the customer’s behavior to pay membership fees. There is always the bull/bear argument on whether or not Costcos fees are sustainable. I would bet they are. It is not a “one or the other” type of arrangement for customers. You can have an Amazon Prime membership and a Costco membership. The disloyalty police do not come knocking on your door. I would like to know the statistics on how many customers have both. I think the results would be surprising. For now, that will have to be a number we can only guess at, as I dont see Amazon and Costco working together to reveal that information.

But at Costco, it seems you really do get something for your membership. Here is where Costco shines. By only having a limited inventory and limited SKU selection it can really drive value on its customers’ needs. Here is a quote right from its corporate web page

Commitment to quality. Costco warehouses carry about 4,000 SKUs (stock keeping units) compared to the 30,000 found at most supermarkets. By carefully choosing products based on quality, price, brand, and features, the company can offer the best value to members.

So, lets take a real-world example. While researching this piece, I took an item from Costco and compared it directly to the same item on Amazon. I was more than a little surprised by the price disparity.

Louisiana Champion Pellet Grill & Smoker

At Amazon, this Louisiana Grills Champion Pellet Grill retails for $1533 + $230.49 shipping. The same exact item at Costco is listed at $1,199.99 with Shipping & Handling included. Thats pretty big savings! Seems a popular item as when I checked back, it now says Out Of Stock on Costcos site. Looking at the comments section on Amazon, some noted the item on Costcos site as listing at $999 at one point.

In general, I would say nearly any item you find at Costco will be of value. When Costco only marks the product up 15-17%, It would be difficult for any other retailers to match.

With more and more people accepting the concept of membership fees (thank you, Amazon), I dont think the bears’ argument that people will stop paying is rational.

Point 3 Lets talk about quality

In the new world of retail, where nearly anything can be bought online, how do you control the quality? With everyone and their brother setting up Shopify (NYSE:SHOP) stores and selling direct from Aliexpress and Alibaba (NYSE:BABA), whos keeping an eye on the quality?

I recently served as COO for a large manufacturing company here in Cebu, the Philippines. Costco was one of our newer customers. The level of quality control it required of us was incredibly detailed. The weight (of a hand cast, stone cast item) had to be in a range of 0% to +5% of list. Most of our customers give us a 20% leeway. Our first samples went to a testing lab where it conducted 47 pages of tests on the product. These included special designed weight tests (It was a Garden stepping stone item) with various forces applied for various times from different angles. Sun exposure tests, chemical tests, every paint was tested for lead. It performed acid tests on durability, finish strengths, color, nearly everything and more, that one could think of. Before final shipment, Bureau Veritas, a highly regarded 3rd party testing agency, sent three people who tested our final products for two days straight. Costcos testing requirements are much more rigorous than what we observed for other mass market retailers.

Because Costco has such a narrow SKU focus, it can really attend to the marketability, quality, price, and function of its products. I came away from that experience thinking to myself I feel pretty good about anything I buy at Costco.

Amazon does not have this luxury. The company cannot possibly perform this level of detailed quality control on its items.

Costco 4000 SKUs.

As of January 2017, Amazon had 372.5 million SKUs.

This gives Costco an enduring and competitive advantage on quality.

Point 4 Here is where I think the market really has Costco right. Retail 3.0

Yes, it seems an expensive stock. Yes, it has run straight up lately. But lets think about how retail has changed. Uh oh, did he just say, This time is different? Yes, I did! This time it is different and thats what the stock chart has been telling us.

Lets explore what has changed.

Retail 1.0 First we had the good old-fashioned stores. They put up a physical presence in an area, sold their wares, tried to get more traffic and expand locations. They traded at conventional market multiples of, lets just say, X times earnings/cash flows etc. Fine

Retail 2.0 Then of course came the internet. No longer should we be burdened by the overhead of those pesky, out-of-date, Brick & Mortar retailers. Everything was going to go online. Every B&M was going to be put out of business. As trust grew with online purchases, the market potential (and some market caps) began to soar.

But what multiple should Retail 2.0 trade at? Still a work in progress on figuring that out, but the market has come a long way in the last 20 years on this topic. At least we arent referencing internet stocks like the old days as a multiple on eyeballs and page views. Matter of fact, we really dont even call them internet stocks anymore.

But doesnt it make sense that a company with less physical assets and without the burden of rents/employees/overhead should trade at a larger multiple maybe 2x or 3x. I dont really know the answer to that question, but I do know the answer to the next point.

Retail 3.0 Somewhere along the way of all B&M going out of business, a funny thing happened it didnt. Suddenly, many of the traditional B&Ms learned how to compete online. Home Depot (NYSE: HD) is one of the greatest examples. Just considering its e-commerce sales, Home Depot is the #7 largest internet retailer!

Suddenly having physical locations across the country is no longer a liability. It is a real asset. Costco can out Amazon (its a verb), Amazon. It has many ways to leverage its physical assets.

BOPIS Buy Online, Pickup in Store today BOSS Buy Online, Ship to Store BORIS Buy Online, Return to Store BODFS Buy Online, Deliver from Store

As Amazon tries to build out a physical footprint, Costco is already there. You could even say that Amazons purchase of Whole Foods was a complete validation of the Retail 3.0 concept. Amazon recognized its weakness and is moving to correct it. The market is finally beginning to validate the physical presence of companies who also sell online. Retail 3.0 is the integration of B&Ms into an online world.

Shouldnt companies, with these new revenue levers, simply trade at higher multiples than the Five & Dimes of the past? Can you really value these stocks in the same manner as before?

So how about the stock?

I understand Im taking a big risk here. Ive gone full heretical. This is exactly what a top-tick article looks like. But I will be buying my first purchase of Costco stock this week. Would I love to wait for a pull-back? Sure, but not even a Genie can tell you when and how that will happen. Ill build a small and growing position. It really wont matter that much whether I bought at 180 or 190 when the stock reaches 500. How long will that take? Probably more than a few years, but I can be patient. Sometimes you have to leave the meat in the smoker for good long while.

Why not buy your full position now then? Well, I still think Costco will have some margin pressure (due to packaging article in link) in the next 6-12 months. Not sure how much that will be. If it takes the stock down some, Id like to have room to buy more. Plus, as I rotate out of other stocks, Ill have more available capital to put to work in Costco. This isnt a short-term trade for me. If my theory is correct, that Costco will begin to be more appreciated by the market for its retail 3.0 progress, my holding period will be measured in years. If Im wrong, and the world hasnt changed, well there is that nice dividend still right?

As always, best of luck to all. I’ll continue to update the Asia packaging problems in my blog as I have new information.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in COST over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Largest holdings are HOME, BP, NEWR. I will be purchasing COST this week.

About this article:ExpandAuthor payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.Tagged: Investing Ideas, Long Ideas, Services, Discount, Variety StoresWant to share your opinion on this article? Add a comment.Disagree with this article? Submit your own.To report a factual error in this article, click here

Costco – Why The Market Might Be Right

I think we can all agree the market can at times be, shall we say myopic? But in the long run, the market has a great way of separating the winners from the losers. It is the summation of all thoughts, fears, demand, supply, and even a bit of greed. The market is the consummate weighing machine of not the past, but the prospects of a company.

So, when I see Costco (NASDAQ: COST) trading at all-time highs, with a large expansion in its market multiple its easy to dismiss this as Ahh the market is overvaluing this company and to be skeptical. I was cautious on the stock at $158. But it is more prudent to try to understand just why the market seems so in love with Costco lately and why I had it so wrong.

Chart
COST data by YCharts

Nice chart lately. You can see the noise effects of Amazons (NASDAQ: AMZN) foray into Whole Foods. The pros/cons of that purchase have been repeatedly covered here on Seeking Alpha. A 2nd chart below, with a more expanded time frame, shows Costcos Trailing Twelve Month (TTM) P/E Ratio. Note, the stock is not that far above its historical average P/E multiple.

Chart
COST data by YCharts

The value folks are screaming Sell! and the long-term holders are simply saying Yawn. If the short argument is that the stock is overvalued that is a bit of a stretch, but you could make that case. But how overvalued? 20-30 points or so? Not a compelling risk-reward. Shorting stocks on valuation is almost always the wrong approach.

Sometimes its just as simple as this, the best stocks always seem overvalued. But in Costcos case, Im going to outline 4 reasons why the market might have this one right. I progress from the rather obvious point 1 to the bit more obscure point 4.

Point 1 – Solid management and a long-term, laser-like focus on its customers and needs.

No new revelations here, but Costcos management is well regarded. Employees are treated rather well for a retailer. 88% of Costco Employees have company-sponsored healthcare. Coincidentally, 88% of Costco employees think they are Fairly Paid. A loyal workforce and low turnover have always been a Costco staple. Not an earth-shattering observation I know, but still refreshing to see.

Point 2 The membership program, and the effect on gross margins.

Of course, we all know that Costco has a membership fee. This allows the company to sell products at a razor-thin margin. The company’s yearly gross margins, dating back to 2008, can be seen here. Lately, margins have been about 13.3%. Yes, that includes its membership fees. But the world is changing. Here is where Amazon might have helped Costco. It is now very well engrained into the customer’s behavior to pay membership fees. There is always the bull/bear argument on whether or not Costcos fees are sustainable. I would bet they are. It is not a “one or the other” type of arrangement for customers. You can have an Amazon Prime membership and a Costco membership. The disloyalty police do not come knocking on your door. I would like to know the statistics on how many customers have both. I think the results would be surprising. For now, that will have to be a number we can only guess at, as I dont see Amazon and Costco working together to reveal that information.

But at Costco, it seems you really do get something for your membership. Here is where Costco shines. By only having a limited inventory and limited SKU selection it can really drive value on its customers’ needs. Here is a quote right from its corporate web page

Commitment to quality. Costco warehouses carry about 4,000 SKUs (stock keeping units) compared to the 30,000 found at most supermarkets. By carefully choosing products based on quality, price, brand, and features, the company can offer the best value to members.

So, lets take a real-world example. While researching this piece, I took an item from Costco and compared it directly to the same item on Amazon. I was more than a little surprised by the price disparity.

Louisiana Champion Pellet Grill & Smoker

At Amazon, this Louisiana Grills Champion Pellet Grill retails for $1533 + $230.49 shipping. The same exact item at Costco is listed at $1,199.99 with Shipping & Handling included. Thats pretty big savings! Seems a popular item as when I checked back, it now says Out Of Stock on Costcos site. Looking at the comments section on Amazon, some noted the item on Costcos site as listing at $999 at one point.

In general, I would say nearly any item you find at Costco will be of value. When Costco only marks the product up 15-17%, It would be difficult for any other retailers to match.

With more and more people accepting the concept of membership fees (thank you, Amazon), I dont think the bears’ argument that people will stop paying is rational.

Point 3 Lets talk about quality

In the new world of retail, where nearly anything can be bought online, how do you control the quality? With everyone and their brother setting up Shopify (NYSE:SHOP) stores and selling direct from Aliexpress and Alibaba (NYSE:BABA), whos keeping an eye on the quality?

I recently served as COO for a large manufacturing company here in Cebu, the Philippines. Costco was one of our newer customers. The level of quality control it required of us was incredibly detailed. The weight (of a hand cast, stone cast item) had to be in a range of 0% to +5% of list. Most of our customers give us a 20% leeway. Our first samples went to a testing lab where it conducted 47 pages of tests on the product. These included special designed weight tests (It was a Garden stepping stone item) with various forces applied for various times from different angles. Sun exposure tests, chemical tests, every paint was tested for lead. It performed acid tests on durability, finish strengths, color, nearly everything and more, that one could think of. Before final shipment, Bureau Veritas, a highly regarded 3rd party testing agency, sent three people who tested our final products for two days straight. Costcos testing requirements are much more rigorous than what we observed for other mass market retailers.

Because Costco has such a narrow SKU focus, it can really attend to the marketability, quality, price, and function of its products. I came away from that experience thinking to myself I feel pretty good about anything I buy at Costco.

Amazon does not have this luxury. The company cannot possibly perform this level of detailed quality control on its items.

Costco 4000 SKUs.

As of January 2017, Amazon had 372.5 million SKUs.

This gives Costco an enduring and competitive advantage on quality.

Point 4 Here is where I think the market really has Costco right. Retail 3.0

Yes, it seems an expensive stock. Yes, it has run straight up lately. But lets think about how retail has changed. Uh oh, did he just say, This time is different? Yes, I did! This time it is different and thats what the stock chart has been telling us.

Lets explore what has changed.

Retail 1.0 First we had the good old-fashioned stores. They put up a physical presence in an area, sold their wares, tried to get more traffic and expand locations. They traded at conventional market multiples of, lets just say, X times earnings/cash flows etc. Fine

Retail 2.0 Then of course came the internet. No longer should we be burdened by the overhead of those pesky, out-of-date, Brick & Mortar retailers. Everything was going to go online. Every B&M was going to be put out of business. As trust grew with online purchases, the market potential (and some market caps) began to soar.

But what multiple should Retail 2.0 trade at? Still a work in progress on figuring that out, but the market has come a long way in the last 20 years on this topic. At least we arent referencing internet stocks like the old days as a multiple on eyeballs and page views. Matter of fact, we really dont even call them internet stocks anymore.

But doesnt it make sense that a company with less physical assets and without the burden of rents/employees/overhead should trade at a larger multiple maybe 2x or 3x. I dont really know the answer to that question, but I do know the answer to the next point.

Retail 3.0 Somewhere along the way of all B&M going out of business, a funny thing happened it didnt. Suddenly, many of the traditional B&Ms learned how to compete online. Home Depot (NYSE: HD) is one of the greatest examples. Just considering its e-commerce sales, Home Depot is the #7 largest internet retailer!

Suddenly having physical locations across the country is no longer a liability. It is a real asset. Costco can out Amazon (its a verb), Amazon. It has many ways to leverage its physical assets.

BOPIS Buy Online, Pickup in Store today BOSS Buy Online, Ship to Store BORIS Buy Online, Return to Store BODFS Buy Online, Deliver from Store

As Amazon tries to build out a physical footprint, Costco is already there. You could even say that Amazons purchase of Whole Foods was a complete validation of the Retail 3.0 concept. Amazon recognized its weakness and is moving to correct it. The market is finally beginning to validate the physical presence of companies who also sell online. Retail 3.0 is the integration of B&Ms into an online world.

Shouldnt companies, with these new revenue levers, simply trade at higher multiples than the Five & Dimes of the past? Can you really value these stocks in the same manner as before?

So how about the stock?

I understand Im taking a big risk here. Ive gone full heretical. This is exactly what a top-tick article looks like. But I will be buying my first purchase of Costco stock this week. Would I love to wait for a pull-back? Sure, but not even a Genie can tell you when and how that will happen. Ill build a small and growing position. It really wont matter that much whether I bought at 180 or 190 when the stock reaches 500. How long will that take? Probably more than a few years, but I can be patient. Sometimes you have to leave the meat in the smoker for good long while.

Why not buy your full position now then? Well, I still think Costco will have some margin pressure (due to packaging article in link) in the next 6-12 months. Not sure how much that will be. If it takes the stock down some, Id like to have room to buy more. Plus, as I rotate out of other stocks, Ill have more available capital to put to work in Costco. This isnt a short-term trade for me. If my theory is correct, that Costco will begin to be more appreciated by the market for its retail 3.0 progress, my holding period will be measured in years. If Im wrong, and the world hasnt changed, well there is that nice dividend still right?

As always, best of luck to all. I’ll continue to update the Asia packaging problems in my blog as I have new information.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in COST over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Largest holdings are HOME, BP, NEWR. I will be purchasing COST this week.

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