Many investors absolutely love Costco Wholesale (COST 0.07%) stock. But the late, great Charlie Munger might have been the most head-over-heels for this warehouse-style retail chain. Shortly before he passed away, he did an interview with the Acquired podcast and explained some of the desirable traits of Costco’s business model.
Munger, Warren Buffett’s right-hand man, talked about how it delivers exceptional value to its customers, who in turn deliver exceptional loyalty.
For the unaware, Costco keeps prices low because it’s not trying to make much money from its retail business. Rather, the majority of its profits comes from selling memberships to those who shop at its stores.
Another desirable trait of Costco’s business model is the size of its stores. As Munger pointed out, the company doesn’t want to open an unlimited amount of locations. It only wants to operate in places that can support a huge warehouse store that handles incredibly high sales volume. By opening bigger stores in fewer locations, Costco keeps its occupancy costs lower than some competitors.
Without a doubt, Costco is a great business, and investors are right to love it. That said, I like to buy stocks that are good businesses and that also trade at a good valuation. And Costco just doesn’t meet that second test right now. As the chart below shows, its price-to-sales (P/S) valuation and its price-to-earnings (P/E) valuation just hit their highest levels in over 20 years.
I think Costco is a great business, but the stock is too hot to handle right now for those looking to invest new money. For that reason, I want to highlight BJ’s Wholesale Club (BJ -1.10%), Floor & Decor (FND -0.02%), and Academy Sports and Outdoors (ASO -0.53%). These three are creating shareholder value by implementing some of the traits that make Costco great, and all three are better buys right now.
1. BJ’s Wholesale Club
BJ’s didn’t just imitate Costco in certain areas; it completely copied the playbook, and that’s a good thing. In 2023, membership fees accounted for about 80% of the company’s profits (similar to Costco’s economics). This shows that it’s important for BJ’s to grow its membership base if it’s going to grow its profits.
This has been happening for BJ’s. Consider that when the company went public in 2018, it had about 215 club locations compared to 244 locations today. Therefore, it has grown its store base by about 13%. But its membership base has grown by about 35%, meaning members per club are up, which is good news.
BJ’s management hopes this trend continues. But it also plans to grow its membership base by opening new stores. The company plans 12 new stores this year with several of them opening in under-penetrated markets.
Revenue growth for BJ’s should be modest but consistent. And I like the company’s chances to increase its profits by growing its membership base. But the cherry on top is that BJ’s stock trades at a P/E of just 19 — less than half the valuation of Costco stock even though its growth prospects are comparable.
2. Floor & Decor
Home-improvement retailer Floor & Decor isn’t a membership-based business. But Munger wasted no time in calling this company a Costco copycat nonetheless.
Here’s how it’s copying Costco: Floor & Decor doesn’t address the entire home-improvement space, and it doesn’t intend to operate a huge chain. Rather, it mostly addresses flooring, and it’s only aiming for 500 locations by 2030. But these stores — like Costco’s — are huge at 78,000 square feet on average. And they’re strategically located to accommodate high sales volume.
For perspective, Floor & Decor had only 221 locations at the end of 2023. Therefore, it intends to more than double its store base over the next six years. The stock’s valuation is higher than Costco’s — it’s true. However, growth for Floor & Decor should be far superior as it more than doubles in size, which justifies its higher price tag.
3. Academy Sports and Outdoors
Lastly, Academy Sports is also running with Costco’s idea of having bigger stores in fewer locations to support better profits. It’s proud that its stores do $22 million in sales volume on average.
As of March 26, Academy Sports had 283 stores. But in five years, it hopes to have between 442 and 462. That’s a strong growth plan.
It doesn’t just plan to open new stores. Management has diligently worked to manage expenses and improve margins. As the chart below shows, its net-profit margin has increased sharply since it went public in 2020, giving management more cash to pay a growing dividend and pay down its debt considerably from peak levels.
And it isn’t done yet. Over the next few years, it hopes to reach $10 billion in annual sales and achieve a 10% net margin. This simple math says that $1 billion in net income is within its grasp. And for perspective, the company has a market cap of just $5 billion.
Let’s suppose that Academy Sports’ management only makes it halfway to its goal and hits $500 million in net income. And let’s also say that the stock trades at half of the P/E of the S&P 500 (half would be about 11.5 times earnings). Even in this really bad scenario, Academy Sports stock has modest upside. And hitting its goals points to easy market-beating upside.
In closing, Costco stock has done wonderfully for investors because it has a good business model. But BJ’s Wholesale, Floor & Decor, and Academy Sports share aspects of its business model that also make them attractive companies. And each one could have higher upside than Costco stock over the next several years, which is why I believe they’re better buys today.