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Introduction 

Costco Wholesale Corporation (Costco) is a major global retailer, known for its membership-based model and bulk product sales. The company is publicly traded on the NASDAQ stock exchange under the ticker symbol COST. As of October 4, 2024, Costco's stock price was $883.11 per share (Costco Wholesale Corporation, 2024). Costco operates within the highly competitive retail industry, specifically in the warehouse club segment, where it stands out due to its bulk pricing, private-label brand, operational efficiency, and unique "treasure hunt" shopping experience, which attract quality-conscious consumers seeking bargains (Costco Wholesale Corporation, 2023). 

To evaluate how Costco’s stock is valued in the market, it is essential to understand the two types of investors influencing its valuation: the average investor and the marginal investor. This analysis will explore the characteristics of both types and their role in shaping Costco's stock price. The analysis is based on Costco’s publicly available annual report and audited financial statements (10-K). 

Average Investor: The average investor is typically a retail or individual investor who invests their own capital in stocks, bonds, mutual funds, and ETFs. These investors often make decisions influenced by emotions, market timing, or sentiment, which can lead to suboptimal financial outcomes (Financial Symmetry, 2024). In the context of Costco, the average investor may be a Costco member who invests in the company due to personal experience and brand loyalty. These individual investors often rely on public information and are prone to market trends, lacking the comprehensive financial analysis that institutional investors may utilize (Financial Symmetry, 2024). 

An important distinction is that while average investors are typically individual investors, not all individual investors qualify as average investors. The key differentiators are their impact on the market, trading patterns or methodology, and size of investment. 

While these average investors contribute to Costco’s shareholder base, their influence on the stock price is generally limited due to the smaller scale of their investments. Notable individual investors, like former CEO Craig Jelinek and CFO Richard Galanti, still hold a significant stake in the company, reinforcing their vested interest in its success (Financial Times, 2024).   

Marginal Investor: The marginal investor plays a more critical role in determining Costco’s stock price. This investor type is typically an institutional investor or a high-net-worth individual who holds a substantial number of shares and actively trades them based on detailed financial analysis and risk assessment. Due to their large holdings, marginal investors can influence stock prices through their trading activities (eFinanceManagement, 2022). 

In Costco’s case, institutional investors such as Vanguard Group, BlackRock, Inc., and State Street Corporation are among the primary marginal investors, controlling a significant portion of Costco’s shares through mutual funds, ETFs, and index funds (Nasdaq, 2024; Yahoo Finance, 2024). These investors are drawn to Costco's stable financial performance, defensive nature as a consumer staples company, and long-term growth potential. They rely on rational, data-driven decision-making processes and have access to sophisticated tools and financial research, which enables them to make well-informed investment choices (Baker & Wurgler, 2007). 

Prominent individual investors, such as Charlie Munger, Patrick Callans, and Richard Galanti, all fall under the category of marginal investors due to their significant holdings in Costco. Like institutional investors, they focus on long-term growth and fundamental analysis, avoiding emotional or short-term trading. These individuals, through their strategic, large-scale investments, play a critical role in stabilizing stock prices and influencing Costco’s overall valuation (Financial Times, 2024). 

These investors, both institutional and prominent individuals, are classified as marginal investors due to their ability to move the market with their large-scale trades. Their rational, analytical approach to investing helps stabilize stock prices and influences Costco’s overall valuation (Bodie, Kane, & Marcus, 2020). 

Section 2: Analysis of Risks in Internal and External Financial Environment 

Costco Wholesale Corporation faces a range of significant risks that impact both its internal operations and external financial environment. These risks arise from competitive pressures, macroeconomic conditions, supply chain challenges, and financial exposures, all of which contribute to the company’s risk profile and financial outlook (Costco Wholesale Corporation, 2023). 

Current Significant Risks 

One of the biggest external risks for Costco’s sustainable growth lies in missing out on innovation in the AI era and upskilling its workforce. Technical advancements, especially in AI, offer significant opportunities to improve cost efficiency, optimize resources, and boost productivity. With AI disrupting traditional business processes, it enables companies to rethink their strategies for talent management, operational efficiency, and inventory control. Failing to capitalize on these innovations could result in a loss of competitive advantage, hindering Costco's ability to maintain its market leadership and drive long-term growth. 

Retail industry competitors, such as Walmart and Amazon, have made significant strides in leveraging AI and automation to enhance efficiency, personalize customer experiences, and optimize inventory management. For example, competitors like Target and Walmart are already benefiting from AI-driven forecasting and automation to reduce excess inventory costs and tailor customer interactions, allowing them to respond more rapidly to market changes and consumer needs (Retail Insider, 2023; IHL Group, 2023). Amazon’s use of AI in predictive analytics has revolutionized its inventory and supply chain management, while Walmart employs AI for dynamic pricing, improving customer satisfaction by offering real-time adjustments based on demand and competitor pricing (BCG, 2023; MyTotalRetail, 2023). 

In comparison, although Costco has implemented some technological upgrades, such as improving its mobile app and data management, it has been slower to adopt AI in core areas like inventory management and personalized customer engagement.  

Failing to fully embrace AI-driven innovation could cause Costco to lose its competitive edge in the rapidly evolving retail landscape, leading to higher costs, inefficiencies, and missed opportunities to engage tech-savvy consumers and optimize its supply chain (BCG, 2023). 

The second major risk Costco faces is related to its supply chain. As a company that operates on a bulk-purchasing model and relies heavily on efficient inventory turnover, any disruption in the global supply chain could significantly impact Costco's operations and profitability. The COVID-19 pandemic exposed vulnerabilities in the global supply chain, leading to delays, increased shipping costs, and product shortages—issues that remain relevant in the current environment. Geopolitical tensions, labor strikes at key ports, and rising transportation costs are other external factors that could disrupt Costco’s supply chain, affecting its ability to maintain its low-cost structure (Costco Wholesale Corporation, 2023). 

Additionally, macroeconomic factors can have a substantial impact on Costco’s sales and growth. As the company targets upper-middle-class consumers, fluctuations in employment rates, disposable income, and consumer confidence could directly impact Costco’s sales growth. Economic downturns, inflation, or rising interest rates could weaken the purchasing power of Costco's core customers, reducing their spending on non-essential bulk items. This sensitivity to macroeconomic conditions makes Costco's performance vulnerable to shifts in consumer behavior during times of economic uncertainty (Morningstar, 2024). 

Costco’s risk profile has evolved in recent years, with increased exposure to global supply chain disruptions and macroeconomic volatility. The risk posed by the supply chain has intensified as Costco’s dependence on global suppliers for its products has grown. With the persistent risk of supply shortages or delays, Costco’s ability to maintain inventory levels and its competitive pricing advantage could be compromised. Similarly, macroeconomic risks have become more prominent as inflationary pressures, rising interest rates, and shifts in consumer spending behavior continue to shape the broader retail environment. 

Equity Risk and Cost of Equity 

Costco’s equity remains at a relatively low risk compared to other companies in the retail sector, largely due to its stable revenue growth and strong brand loyalty. The company’s beta of 0.69 reflects lower volatility compared to the broader market, making it a safer investment for risk-averse investors (Yahoo Finance, 2024). However, Costco’s cost of equity has increased from 5.77% in 2019 to 7.73% in 2023, reflecting heightened risks associated with macroeconomic uncertainties and competitive pressures (Costco Wholesale Corporation, 2023). This upward trend in the cost of equity indicates that investors are demanding higher returns to compensate for these growing risks. 

Table 1 Summary of Costco’s key financial ratio trend from 2019 to 2023 

Ratio 

Sep. 01, 20 

NOTE: Calculation Methodology can be found in Spring Liu-Costco Financial Analysis Support Document.xlsx.  

Debt Risk and Cost of Debt 

Costco's debt remains low-risk, thanks to its conservative debt management strategy. The company has steadily reduced its debt-to-equity ratio from 0.44 in 2019 to 0.26 in 2023, demonstrating Costco’s efforts to manage its financial leverage effectively (Costco Wholesale Corporation, 2023). Additionally, Costco's cost of debt has remained stable, rising only slightly from 1.74% in 2019 to 1.96% in 2023, reflecting the company’s strong creditworthiness and access to low-cost financing (Moody’s, 2024). 

Weighted Average Cost of Capital (WACC) 

Costco’s weighted average cost of capital (WACC) has seen an upward trend in recent years, rising from 4.76% in 2019 to 7.63% in 2023 (Costco Wholesale Corporation, 2023). This increase is largely due to the rising cost of equity, which reflects the higher risks associated with macroeconomic factors and supply chain disruptions. A higher WACC means that Costco needs to achieve a higher return on its investments to maintain or improve its financial performance, which may become more challenging in the current environment. 

In summary, Costco’s financial risk profile has been shaped by a combination of external factors, including macroeconomic conditions and supply chain disruptions. While the company has managed its debt effectively and continues to maintain strong brand loyalty, it faces significant challenges from external economic factors and ongoing supply chain uncertainties that could affect its profitability and long-term growth. 

Section 3: Evaluation of Financial Health 

Costco's financial health can be assessed through various financial ratios and metrics, providing insights into both short- and long-term stability relative to the industry and past performance. 

Performance Profile of an Investment in Costco 

Costco’s stock performance between 2019 and 2023 has been exceptionally strong. For example, its stock price grew from approximately $295 in 2019 to nearly $900 in 2023, reflecting a total return of more than 200% (Nasdaq, 2023). Including dividends, the total return for investors would have been even higher, especially given Costco’s history of issuing special dividends.  

Figure 1: Costco 5-Year Stock Price Trend 

NOTE: – data source: Yahoo Finance. (2024). Costco Wholesale Corporation: Shareholder data and trends. 

Comparison to Market: 

Outperformance: Investing in Costco during this period would have significantly outperformed the broader market. For example, while the S&P 500 returned around 70% over the same period, Costco’s stock appreciated by more than twice that amount (McKinsey & Company, 2022).  

With a beta of 0.79, Costco has been less volatile than the market, providing a more stable investment profile. This lower risk, combined with strong returns, makes Costco a compelling investment. 

Comparison to Retail Industry: 

Note: Data source is Yahoo Finance. (2024). Costco Wholesale Corporation: Shareholder data and trends & Csimarket.com, Costco Annual Report calculation + Retail Stock Trends. Retrieved from https://csimarket.com 

Stock Price Growth 

Between 2019 and 2023, Costco’s stock price grew from $295 to $889, reflecting a cumulative growth of approximately 200%. This strong performance far outpaced the retail industry’s average stock price growth, which increased from $250 to $450, a growth of 80% over the same period. The remarkable appreciation in Costco’s stock price is indicative of its robust business model, strong customer loyalty, and efficient financial management. By comparison, the retail sector has faced numerous challenges, including rising operational costs, supply chain disruptions, and evolving consumer preferences, which have slowed stock price growth (Csimarket, 2023). 

Figure 2: Costco Stock Price vs Retail Industry 

NOTE: Data is from Costco Annual Report calculation + Retail Stock Trends (https://csimarket.com)  

Comparison to Retail Industry  

Dividend Growth: Costco’s dividend history further reflects its strong financial position. The company's dividends per share increased from $2.60 in 2019 to $4.20 in 2023, representing a 61.5% increase over five years. In contrast, the retail industry saw more modest dividend growth, with average dividends increasing from $1.50 in 2019 to $2.20 in 2023, a 46.7% increase (Csimarket, 2023). 

Figure 3 – Costco Dividend VS Retail Industry (2019 to 2023) 

Note: – Data source: Csimarket, 2023 

This robust dividend growth signals Costco’s commitment to returning value to its shareholders, supported by strong cash flow generation. The company’s ability to steadily increase dividends, even during times of economic uncertainty, reflects its financial resilience and strong operational performance. In comparison, the retail sector’s slower dividend growth reflects the greater volatility and challenges that many traditional retailers face, including the need to invest in digital transformation and omnichannel capabilities (McKinsey & Company, 2022). 

Costco’s financial position exhibits both short- and long-term strengths and weaknesses. One of the company's primary strengths is its strong cash flow, derived from its solid membership-based business model, which provides a steady and predictable income stream even during economic downturns. This steady cash flow supports Costco’s liquidity, as reflected by its current ratio of 1.05, indicating the company can cover its short-term obligations effectively (Costco Wholesale Corporation, 2023). Additionally, Costco benefits from a low borrowing cost, with its cost of debt at 1.96%, enabling the company to finance projects and growth initiatives at minimal expense (Moody’s, 2024). Costco’s operational efficiency and bulk purchasing power also help maintain low prices, which strengthens its market position for long-term growth. 

However, Costco has some financial weaknesses. In the short term, its quick ratio of 0.56 suggests a reliance on inventory to meet liabilities, which could pose risks during supply chain disruptions (Morningstar, 2024). In the long term, Costco remains heavily dependent on its physical stores, which may limit its ability to compete with e-commerce platforms like Amazon. Another challenge is Costco’s limited product variety, which may not appeal to consumers seeking more specialized products. Additionally, the company’s global expansion brings risks related to foreign currency fluctuations, potentially affecting profitability if local currencies weaken against the U.S. dollar (Costco Wholesale Corporation, 2023). 

Overall, while Costco has a solid financial foundation with efficient operations and low borrowing costs, it must address these potential weaknesses to maintain long-term financial stability. 

Section 4: Current Capital Structure 

Costco utilizes both debt and equity to raise funds, with a focus on conservative debt financing and equity retention. The company primarily uses debt instruments like bonds and corporate loans, capitalizing on favorable market conditions. For example, in 2020, Costco issued corporate bonds at low-interest rates to finance growth and capital expenditures (Costco Annual Report, 2020). This allows Costco to expand without heavily diluting shareholder equity. 

In terms of equity financing, Costco largely relies on retained earnings rather than issuing new shares. Any issuance of shares is typically tied to employee compensation plans, which helps maintain a strong share price and minimizes equity dilution. 

Advantages of Using Debt for Costco 

Cost Efficiency: Debt is cheaper than equity due to tax-deductible interest payments, reducing Costco’s tax burden. In 2023, Costco’s after-tax cost of debt was around 1.96%, much lower than its cost of equity, which was 7.73% (Costco Annual Report, 2023). 

Leverage for Growth: Debt allows Costco to finance expansion without diluting shareholder equity. Costco has used debt strategically to open new warehouses and improve its supply chain (Moody’s, 2023). 

Maintaining Control: By opting for debt, Costco avoids ownership dilution, ensuring existing shareholders retain control. 

Disadvantages of Using Debt for Costco 

Financial Risk: Relying on debt increases financial risk. If revenue declines or interest rates rise, Costco may face higher interest payments, straining cash flow (S&P Capital IQ, 2023). 

Interest Rate Sensitivity: Though Costco benefits from low borrowing costs, rising interest rates could increase debt servicing costs and limit profitability. 

Fixed Obligations: Unlike equity, where dividends are optional, debt requires regular interest payments, which could reduce financial flexibility during economic downturns (Costco Annual Report, 2023). 

Debt Relative to Equity: Too Much or Too Little? 

Costco maintains a conservative approach to debt. Its debt-to-equity ratio decreased from 0.44 in 2019 to 0.26 in 2023, reflecting prudent financial management. This ensures the company does not overexpose itself to financial risk while retaining enough equity to cover obligations. Although Costco’s debt level is conservative, there is room for it to slightly increase leverage, given its strong balance sheet and low cost of debt compared to equity. 

Section 6: Implementing the Optimal Capital Structure 

Adjusting the Debt Ratio 

Given that Costco’s actual debt-to-equity ratio (0.26) is below the recommended optimal range (0.35-0.40), the company should consider gradually increasing its debt financing. This could be achieved by issuing more long-term bonds at favorable rates or taking out corporate loans. Costco could use this additional debt to finance warehouse expansions, enhance supply chain infrastructure, or invest in AI and automation technologies to remain competitive in the retail space (BCG, 2023). The gradual approach would allow Costco to avoid shocking its financial structure while taking advantage of lower debt costs. 

Achieving Optimal Cost of Capital 

To lower its cost of capital, Costco should focus on reducing its reliance on equity financing, which has a higher cost, and slightly increase its debt levels. One approach could be to issue long-term bonds with a fixed low-interest rate. This would provide Costco with additional liquidity while taking advantage of favorable debt markets. Costco should also avoid issuing new shares unless necessary, to prevent dilution and keep the cost of equity in check (S&P Capital IQ, 2023). 

Gradual vs. Immediate Adjustment 

Costco should implement these changes gradually rather than immediately. A measured increase in debt will allow the company to monitor the effects on its financial stability and market perception. This approach will also give Costco time to invest in productivity-enhancing technologies without overburdening itself with fixed obligations. 

Altering the Existing Mix 

Costco could consider buying back stock to reduce equity, which would increase the debt-to-equity ratio while returning value to shareholders. Alternatively, Costco could finance new projects through debt, especially if it wants to maintain a low cost of capital. Given that Costco has strong cash flows and a solid balance sheet, issuing bonds or taking on loans for future growth projects is a feasible option that would align with the goal of optimizing the capital structure. 

Conclusion 

Costco's financial health is supported by a strong membership model, steady cash flows, and low borrowing costs, positioning it as a robust player in the retail sector. However, to maintain long-term stability, the company must address external risks such as supply chain vulnerabilities and macroeconomic pressures. While Costco’s current capital structure is conservative, there is room for strategic adjustments to further optimize its cost of capital, particularly by slightly increasing its debt to finance growth initiatives.   

Slight increases in debt could optimize its capital structure, lower its cost of capital, and enhance growth potential. By making these adjustments, Costco can continue to lead in the competitive retail landscape and deliver value to its shareholders over the long term. 

Appendix: Calculation Methodology 

Calculation Table Attachment (it includes the link to ratio assumptions) Spring Liu-Costco Fnancial Analysis Support Document.xlsx 

Reference: 

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Bodie, Z., Kane, A., & Marcus, A. J. (2020). Essentials of investments (11th ed.). McGraw-Hill Education. 

Costco Wholesale Corporation. (2023). Annual report 2023. https://www.costco.com/annual-report 

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