COST has a strong business model and stable financials; current valuation looks attractive for long-term holding.

In this video we will take a look at Costco, whose trading symbol is COST. So in this video , we'll look at the basics of how Costco works. We will review some figures and then try to arrive at a fair value for Costco stock to see if investing in it today is worthwhile.

There may be an opportunity here, because when we look at Costco's stock over the past year or so, the stock hasn't performed much . In fact, it has retreated in the past two months from its recent highs.

So there might be an investment opportunity here.

Basically, for those who don't know Costco, it's a retail company that sells goods wholesale. I personally think Costco is a fairly good company,

One of the interesting aspects of Costco's business is that not all locations are created equal. Where they have a strong presence in the United States and Canada, if they add new stores, it brings different benefits to different people.

Perhaps if I were a Costco member and they opened a new store near me, instead of having to travel a long distance, I could now travel a shorter distance. This might be a good thing.

Or if they are opening a site in a new area where there is no other site nearby, they can get more members , because memberships ultimately help to drive their business.

We can see that they currently have just over 900 sites, and analysts expect them to reach around 1,000 sites within the next two years.

Membership income is approximately 3% of total income. I have heard some people describe this as going straight into net profit. But I'm not sure that's a fair way to look at it, because the way they've done their business is a better description of their business .

So people pay to be members , right? Membership fees represented approximately 3% of total revenue last year.

But in general, Costco customers know they are buying in bulk, but they get good prices. This is helpful, and these good prices and high- quality products at an affordable price are something that has motivated membership.

If they offered inferior products or did not have the products that people wanted, they would not have become members. So, let's say that Costco's system, the efficiency of this system, and the quality of their work are what drive people to subscribe.

If that quality had declined, the membership would not have continued. Therefore, there is definitely a cost to membership.

However, when we look at the numbers, you'll understand why people say it goes straight into net profit. But I think that's a superficial way of looking at it. I read that, and as I reviewed their financial statements and read about their business in their business section , and in their annual report on investors.costco.com, the more I learned, the more I realized that this transaction is not entirely free.

This does not mean that this is simply extra money going to them. There is a cost to satisfying customers.

Now, one of the things they do to boost member loyalty is their ability to offer better prices in many cases. They don't offer that. If you go to your local store, which may have 50 brands offering the same product, Costco is not.

They offer a more focused list of products. In fact, from what I've read, most of their branches carry fewer than 4,000 active varieties at any given time. Therefore, they do not offer 50 different types of toothpaste, but only a few types, and they offer them in large quantities.

Thus, you get a better price as long as you are satisfied with the products they have available . They also have their own brand, "Kirkland," which is again a discounted product, but of reasonable quality, and this is one of the things that attracts many customers to their branches.

Not to mention that they have fuel. Once again, a decent quality product at a reduced price. Therefore , their goal is to offer a large volume at a lower price. This large-scale setup, this large-scale business model , allows them to have simpler processes and better purchasing terms.

When they go to buy from Coca-Cola, Coca-Cola knows that they are buying huge quantities from them. So, it's not the same as buying from a local grocery store. This is a huge quantity because they sell it wholesale.

In any case, this changes the way we look at their work. Ultimately, this leads to what I believe is a stronger business model for Costco. I am a big fan of their business model.

They try to be extremely efficient at what they do. Large brands move them through their branches with high efficiency. They pay their employees fairly well , and they are able to spread operating costs better.

We'll start with revenues, and we can see that over the past decade, revenues have been fairly consistent . It has continued to rise year after year. Although the growth rate is not always a crazy 30-40%, it has been fairly consistent .

I would like to point out that high revenue growth does not necessarily mean high profit growth, because theoretically, if gasoline prices rise as we know they have, revenues will increase even if they sell the same quantity of gasoline compared to the previous year.

Therefore, it is always important to look at indicators such as operating income margins and net profit margins. This basically means, for every $100 Costco generates in revenue, how much of it goes to net profit ?

What is the amount of profit made? In this case , and in the last year, you can see that they made $3.04 in profit. This explains why some say that membership fees, which make up about 2 or 3% of revenue, go directly into net profit because their profit margin is about 3%.

Again, I'm not sure that's a fair way to look at it. If that's the case , I think we're overlooking some of the complexities of the business or how it's run, but you might understand why they do it.

Now, I would like to point out the need to look at the general trend here. In the long run, Costco's trend has been one of gradual upward movement. This is not a company with tremendous growth.

This is a business in a highly competitive market, but they have consistently managed to achieve better profit margins, which is impressive overall.

So, overall, I am quite satisfied with Costco’s ability to gradually improve its business each year. Again, not huge gains, but steady gains.

Let's take a quick look at cash and debt. This is a graph from the last decade, and you can see they have a good amount of cash compared to their debt. The debt was relatively low.

Debts are the orange stripes, and the purple stripes are the cash strips. The cash-to- debt ratio is very good at the moment. By the way, this is cash, short-term investments and long- term investments versus short-term and long-term debt.

If you are wondering what STI and LTI mean, they are short-term investments and long-term investments.

Okay, now let's move on to taking a look at fair value. So, on the Investors Growth website, we have what we call value zones . Essentially, the price-to- earnings ratio of the company is taken and analyzed to see how close it is to the 5-year moving average.

We can now see that Costco stock appears to be undervalued , and appears to be undervalued quite well. Now, if you're wondering how this works, at the top left, you can see that it tells us what returns we would have made if we had bought every day.

This is a daily chart that goes back to the last five years . If you bought every day the stock was in the green zone, how would you perform? In this case, you will be about 40 % more expensive than if you had bought it when it was overvalued.

If you bought it when it was in the red zone, you would be in a roughly neutral position , down by about half a percent. So , you outperform quite well when you buy a stock when it is undervalued.

And now, it seems to be well undervalued . Now, I would like to point out that I was curious . So, on the Investors Growth website, you can switch between our value zones and a traditional price-to-earnings chart with a 5-year moving average .

We can see that it actually appears to be undervalued at the moment. Although from a multiples perspective, Costco stock is currently trading at around 40 times. This number alone seems high, but it is lower than the 5-year average.

And again, from a value perspective, and in relation to its own history, it looks fairly good. This is a company that I think is interesting from a long-term buying and holding perspective .

We've already seen the price chart and the stock hasn't done much over the past year. So, this might actually be an opportunity.

But, as many of you know, I like to double-check my rating. Therefore, another good method of fair value to use here is free cash flow , and discounted free cash flow. Here, I like to use analysts' estimates of free cash flow.

We can see our analysts' estimates for the next five years. The stock appears to be slightly overvalued. This is one of the companies that has been consistently overvalued for a period of time.

I would like to see it in a slightly better position than being valued at 60% above its worth. To me, this seems a bit high . Therefore, I would like to see the stock decline slightly.

But I am confused. I am torn between it appearing to be undervalued from a multiple- profitability perspective. Incidentally, the price-to-earnings ratio is one of the most common valuation methods .

As we have seen with this company, it has clearly proven to be historically effective. Over the past five years, we have performed much better by buying when values are low than by buying when they are high.

So, the situation there seems to be fairly good . But as for the discounted cash flow, I would like to see it decline a little . So, on a personal level, I will add this stock to my watchlist .

We hope to see it decline a little more. The stock price has been relatively stable over the past year. If he retreats a little further, it could be a great opportunity.