According to Buffett, one business was so strong that if someone could only own one stock for the next 50 years, it would be hard to find a better candidate. Have a guess at what it was.

Costco

It’s Costco (NASDAQ:COST). In Buffett’s words: “Costco is an absolutely fabulous organization… If you had to pick one company to own for the next 50 years, you’d have a hard time finding one better than Costco.”

Fair enough. But the really interesting thing isn’t which stock Buffett identified but why he chose it. And it has to do with the company’s business model.

Like a lot of businesses, Costco uses economies of scale to generate a cost advantage. It then passes these on to consumers in the form of lower prices, creating strong customer loyalty.

Holding down prices also makes things extremely difficult for competitors. Any time another retailer increases their prices, Costco looks more attractive by comparison.

The process reinforces itself. Attracting customers helps boost the company’s scale, which increases its cost advantage, which allows it to lower prices even further, attracting more customers.

The stock used to be part of the Berkshire portfolio, but the firm sold its stake, in a move Buffett later described as mistake. And it looks expensive to buy at today’s prices. 

The question for investors, then, is where to find similar businesses to Costco with shares trading at more attractive prices. And I think the place to look might be the FTSE 100.

Compass Group

Compass Group (LSE:CPG) is a contract catering business. That’s a different industry to grocery retail and it can be more cyclical, as investors have been seeing recently.

A recession can force companies to cut back on external spending, threatening demand. But while this is a risk, there are striking similarities between the firm’s business model and Costco’s.

Compass has a big scale advantage, being the largest operator in its industry and around the size of its next two competitors combined. And it uses this to buy ingredients in bulk.

This generates economies of scale, giving the firm a cost advantage. This allows it to be competitive when it comes to contracts, but it’s not the only similarity with Costco. 

One of the most attractive things with Costco is the membership structure. Customers pay a subscription just to shop in their stores – and Compass has something similar.

The firm allows third parties to use its food-buying platform and benefit from the associated savings. But it charges them a fee for doing so, which boosts its margins and profits.

Long-term investing

The first thing Warren Buffett cited in support of Costco was its business model, rather than its growth potential or its profit margins. I think this is quite striking. 

There aren’t many companies that can do what Costco does, but Compass is probably one of the closest comparisons. And it’s one I think investors should consider buying with a view to owning it for the next 50 years.

The post Here’s Warren Buffett’s “1 company to own for the next 50 years” from 2000 appeared first on The Motley Fool UK.

I agree that share prices look high right now, at least in certain sectors. A big drop however, could signal a once-in-a-decade opportunity to get rich. 

Costco

Five years ago, shares in Costco Wholesale Corp (NASDAQ:COST) were trading at $374. That implied a price-to-earnings (P/E) ratio of 41 – higher than Apple or Alphabet. 

If the stock had stayed at the same price, the firm’s earnings growth means it would now be trading at a P/E multiple of around 20. That’s high, but I don’t think it’s unreasonable. 

But Costco shares haven’t stayed where they are – they’re up 130%. And they’ve never really traded at a P/E ratio below 32, even when share prices have been under pressure. 

If the stock had crashed, investors might have had a chance to buy it at an attractive multiple. But this hasn’t happened and that means buying has always come with a significant risk. 

Share prices

High share prices give investors a dilemma. They can either buy at perhaps-unjustified levels and hope prices stay up for long enough to let profits catch up, or they can wait and hope for a crash. 

The trouble is, both of those involve hoping, which I don’t see as a legitimate investment strategy. Fortunately, there’s another option available to investors.

Even when high valuations in some sectors make the stock market as a whole look expensive, there are often opportunities somewhere. The challenge for investors is tracking them down.

Fortunately for UK investors, I don’t think they have to look far. There’s at least one in the FTSE 100 that jumps out me as a stock worth considering right now.

Bunzl

Bunzl‘s (LSE:BNZL) a FTSE 100 distributor of non-food consumables. That means things like disposable tableware, carrier bags, packaging, and safety equipment. 

The stock’s down 25% this year, mostly due to weak demand in the US. But some operational missteps in its shift to own-brand products didn’t exactly help matters.

This highlights the fact that no stock’s without risk and a US recession is an ongoing threat. The firm however, seems to have got things back on track relatively swiftly. 

Bunzl’s strategy of acquisitions to drive growth has been a rewarding one for shareholders. And a fragmented market means I think there’s a good chance it continues for some time.

Finding opportunities

Investors looking to buy shares should welcome a stock market crash. Lower prices would likely create opportunities that don’t come around often in the normal course of business.

I think it would be far worse if the overvalued parts of the market stayed expensive until company fundamentals catch up. That would make buying risky.

I’ve got a list of shares I’m looking to buy if the stock market crashes. But I also think there are good enough opportunities for me to take advantage of while I wait for that to happen.

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Stocks that trade at big earnings multiples can be a great investment. Charlie Munger’s Costco Wholesale (NASDAQ:COST) example illustrates this perfectly.

A Charlie Munger recommendation

At the 2022 Daily Journal shareholder meeting, Munger said the following:

I’ve always believed that nothing was worth an infinite price. So at some [point] even an admirable place like Costco could get to a price where you would say ‘that’s too high’. But I would argue that if I were investing money for some sovereign wealth fund, or some pension fund and had a 30, 40, or 50-year time horizon, I would buy Costco at the current price.

When Munger said this, Costco stock was trading at $512 per share. Since then, the share price has reached $982 and the company has distributed just under $27 per share in dividends.

That’s a total return of 97%, which is comfortably ahead of the S&P 500. And when Munger made that statement, Costco shares were trading at a P/E multiple of 44, which is high by anyone’s standards.

Why has Costco outperformed?

There are two main reasons Costco has outperformed since 2022. One is the growth from the underlying business – earnings per share (EPS) has increased by 26% over the last couple of years. 

Costco EPS 2020-24

Created at TradingView

That increase in EPS has been compounded by an expanding P/E multiple. The stock has gone from trading at 44 times earnings in 2022 to 58 times now.

Costco P/E ratio 2020-2024

Created at TradingView

That’s not only high by the standards of the S&P 500, it’s historically high for the company. And Munger did acknowledge that it was – in principle, at least – possible for the stock to become overpriced.

The big risk for investors considering buying Costco shares is that the company doesn’t grow fast enough to justify the current P/E multiple. And I think this a concern to take seriously. 

Where does growth come from?

Over the last 10 years, Costco’s operating margins have been remarkably stable. That’s not a big surprise for a business that is focused on customer value and avoids pushing up prices.

Costco operating margins 2015-2024

Created at TradingView

The result is that earnings growth is driven by higher sales. And there are two main ways the company can keep increasing revenues in future – open more stores, or sell more from existing ones.

Over the last decade, the number of Costco stores has increased by an average of around 30 per year. That’s about 3% of the current store count, which isn’t particularly striking in terms of growth.

Equally, like-for-like sales growth has typically been around 7% per year. Even combining this with the new store openings, it’s going to take a long time before the current share price looks cheap.

Long-term investing

This is where long-term investors have an advantage. It’s hard to see how Costco’s valuation makes sense over a short time horizon, but if it can grow over a period of decades, things might be different. 

Should investors still consider Costco shares at today’s prices? I’m undecided, but I certainly don’t think the high P/E multiple is a reason to dismiss it out of hand.

The post Charlie Munger recommended shares in this growth company back in 2022. Here’s what’s happened since appeared first on The Motley Fool UK.

Equally though, I think it’s important to invest only when the price is right. And right now there are a few stocks I’d like to buy… but only if the opportunity presents itself.

Quality shares

When I invest, I look to buy stocks that will provide returns for a long time. That means the most important thing to find is a business that will prove durable. 

This usually means a firm that dominates its industry or has something that differentiates it from its competitors. This allows the company to generate strong shareholder returns.

The trouble is, shares in these businesses are typically expensive. And even the best shares can be bad investments if the price is too high. 

Despite this, the stock market has a way of doing unexpected things. So it’s worth being prepared for opportunities that might present themselves.

Diploma

I sold my stake in FTSE 100 distribution company Diploma (LSE:DPLM) just over a year ago at a price of £28.18. The stock is now trading at £41.52.

Diploma isn’t just a distributor. It differentiates itself by offering a bespoke service, strong technical knowledge, and a scale that allows it to get products to customers quickly.

This makes it difficult to disrupt, but I decided the stock was too expensive and sold it. Since then, the company has grown strongly both organically and through acquisitions.

I still find it hard to consider buying it today at a price-to-earnings (P/E) ratio of 48. But if that comes down in July, I’d love to buy it for my ISA again.

CostCo

CostCo Wholesale (NASDAQ:COST) is one I’d love to own in my ISA. It has the lowest prices in the industry and a business model that helps it maintain this position.

Unlike other retailers, CostCo charges a membership fee to shop in its outlets. Having this additional revenue stream allows it to charge less for products than its competitors.

This attracts more customers, which results in more membership fees and the cycle repeats. It’s a terrific strategy that has taken the stock from $268 to $862 over the last five years.

Given its size, I’ve become a little wary of CostCo’s growth prospects. I therefore wouldn’t buy it at a P/E ratio of 53, but I’d jump at the chance to buy shares at a better price.

Investing: the basics

Fundamentally, for shares in a company to be a good investment, the business has to generate enough cash to justify the current price. That’s the basic idea behind investing.

At the moment, Diploma has a market cap of £5.5bn and generates £187m in free cash – a 3.5% return. CostCo earns $7.4bn with a market cap of $381bn, which is a 1.9% return.

A lot of growth is therefore already priced into both stocks, so I’m watching them from the sidelines for now. But if a better opportunity presents itself, I’ll be ready to make a move.

The post 2 picks I’d love to add to my Stocks and Shares ISA in July appeared first on The Motley Fool UK.

Which is better? The boring answer is that it depends on the individual, but I think there’s a fun way to tell whether someone is better suited to growth stocks or value shares.

A test case

I think CostCo Wholesale (NASDAQ:COST) is a terrific case study. A £10,000 investment in the stock five years ago would be worth £32,578 today and the rising share price is no accident.

The company is a retailer with an almost unreasonable focus on low prices. And it has a number of advantages that allow it to do this without undermining its own profitability. 

These include the company’s membership scheme, its limited product range, and the layout of its stores. Together, these put CostCo in a powerful commercial position.

Despite this, investors are wary about buying the stock at the moment. And the reasons why help illustrate the difference between growth investors and value investors.

Growth vs value

One reason to hesitate when considering CostCo is its growth. Sales have grown by an average of 7% per year over the last 10 years, but this could be difficult to maintain.

On average, the company opens around 25 warehouse stores each year. But this makes less of a difference with the store count at 876 than it was in 2012, when it had 608 outlets.

Source: Statista

Another reason for caution is price. The stock currently trades at a price-to-earnings (P/E) ratio of 51, which is very high and implies an earnings yield of just under 2%. 

Even for a company as strong as CostCo, it’s difficult to find this attractive when a 10-year government bond offers an annual yield above 4%. So valuation is also a potential issue. 

Which is more important?

Both are good reasons, but which matters more? I think the answer investors give goes some way towards indicating whether they should focus on growth stocks or value shares.

Investors most concerned with revenue growth should probably focus on growth stocks. There are several companies that are likely to grow sales by more than 7% per year in future.

By contrast, those who think the biggest issue is a P/E ratio of 50 are likely to do better with value shares. Plenty of stocks trading at P/E multiples below 15 are worth a look right now.

In my view, neither is entirely right or wrong. That means I probably don’t neatly fall into either category of investor, so what should I do to try and find stocks to buy?

Investing £10,000

If I were investing £10,000 today, I’d try to listen to Warren Buffett’s advice. The best investors, according to the Berkshire Hathaway CEO consider both growth and value. 

Put simply, they focus on buying stocks for less than they’re worth. But how much they’re worth is determined by their future growth prospects. 

I think there are a number of stocks that fit the bill right now – some growth stocks and some value shares. So it’s a good time for investors like me at the moment.

The post With £10,000 to invest, should I buy growth stocks or value shares? appeared first on The Motley Fool UK.

Nonetheless, the stock market is volatile and highly unpredictable. That means it’s worth having a list of shares to buy in a sell-off, in order to be ready for when an opportunity presents itself.

Quality stocks

What makes a great stock for an investor to own? The answer comes down to two things. 

First and foremost, the underlying business needs to be one that can generate a lot of cash. This is what drives the return, so it’s an essential part of a great investment.

Second, there needs to be something that acts as a barrier to competitors. A business with great economic properties is unlikely to keep generating returns if it’s easy for others to do the same.

With this in mind, here are two shares I think fit the bill. Both of them look too expensive right now, but either could be terrific if bought at the right price. 

Diageo

Diageo (LSE:DGE) is an alcoholic drinks company. In my view, its business is one of the strongest on the FTSE 100. 

Diageo generates around £5bn in operating income using £6bn in fixed assets. This means that it ticks the first box – it generates a good return considering how much it costs to run.

Alcoholic beverages can be a crowded marketplace, so there’s a risk of artisanal brands taking market share. But the business has some important advantages that limit this threat

First, Diageo has some first-rate brands. These give the company negotiating power with retailers that smaller participants don’t have. 

Second, its scale gives it a big advantage. It means that marketing, distribution, and manufacturing costs are lower.

The stock currently trades at a price-to-earnings (P/E) ratio of 23, which I think is a lot for a business growing its revenues at 5%. In a market sell-off, though, I’d be looking to buy it.

If the share price dropped sharply, though, things might well be different. I think Costco would be a great stock to own, if only it were available at a substantially lower price. 

Costco

Another stock on my list is discount retailer Costco (NASDAQ:COST). At a P/E ratio of 36, this is quite a way above the level I’d be interest in, but the underlying business looks excellent.

In general, retail companies don’t tend to make great investments. Low profit margins and fierce competition means that inflation can be a significant risk.

This is true of Costco. But the company’s membership fee revenue gives it a source of income that doesn’t depend on product margins. 

This is what helps the retailer maintain lower prices than other retailers. And those low prices keep attracting customers who are willing to pay the membership fee.

Basically, Costco’s two strengths are mutually reinforcing. Customers pay to join because they know they’ll get low prices and the fee revenue allows the business to keep prices down.

The company’s business model is almost impossible for a competitor to replicate due to its size. That’s why I think it would be a great investment at the right price.

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The stock is Costco Wholesale Corporation (NASDAQ:COST). It’s a huge part of Charlie Munger’s investment portfolio and I think it could be a great addition to mine.

Buying Costco shares isn’t without risk. The falling value of the pound and the fact that Costco shares aren’t cheap both constitute significant risk factors for me as a UK investor.

The underlying business, though, looks exceptionally strong and I think that buying shares in October should help my portfolio weather a storm in financial markets.

The business

Costco is a retailer that sells large quantities of products to customers at low prices. Its products are so cheap, in fact, that it’s hard to see how they make any money selling them.

The truth is, they don’t really make much money from selling products. Instead, the company generates profit by having its customers give them money for nothing.

Well, sort of. Costco shoppers pay an annual fee to be able to shop in the company’s various warehouses, and this is what drives profitability.

In many ways this is the dream for a business. But it relies heavily on the company having a certain brand power and a presence in the mind of its customers.

For this model to work, Costco needs a reputation for having the lowest prices. If a product might be cheaper somewhere else, then there’s no point in paying for a Costco subscription. 

In other words, Costco has to convince its customers that it’s not even worth shopping around to find the best deals. And I think that it does this very well.

Earnings

Costco reported its quarterly earnings recently. Revenues were up 15% compared to the same quarter a year ago and profits were up 11%.

This tells me a couple of things. The first is that this looks like a classic example of a business dealing with inflation and the second is that the business is likely to fare well in a recession.

In an inflationary environment, I’d expect higher revenues as consumer spending increases and lower margins as costs also increase. That’s exactly what these numbers look like to me.

Higher revenues also indicate to me that Costco can fare well in a recession. Even as economic conditions tighten, the company’s reputation for low prices will continue to attract customers.

There’s evidence that this is already happening. Renewal rates for Costco memberships reached record high rates of 93% in the last quarter, indicating that demand remains strong.

A stock to buy in October

Even with fears of a recession on the horizon, Costco’s business continues to do well. This, to me, sets it apart from the crowd as I look for stocks to buy in October.

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