Charlie Munger became famous in the investment world as Warren Buffett’s right-hand man at Berkshire Hathaway and the architect of Berkshire’s philosophy of buying great businesses at fair prices versus the prior mantra of buying good businesses at great prices.
Over a nearly 100-year life, Munger would pass up innumerable investment opportunities, choosing to put money only into the few that truly offered exceptional value.
One stock that Charlie Munger became an unreserved fan of was Costco (NASDAQ:COST). Munger built up a personal stake in the business that became worth more than $100 million and strongly advocated for Berkshire to make large investments in Costco as well.
Though Buffett did buy some COST shares on Munger’s recommendation, he ultimately left money on the table by selling them in 2020.
Here are three reasons why Munger was such a fan of Costco that allowed him to beat even Warren Buffett’s legendary stock-picking prowess by holding when the Oracle of Omaha sold.
Key Points
- Costco’s customer loyalty, driven by low prices and high-value memberships, created a durable competitive moat.
- Munger admired Costco’s ethical management, high employee wages, and customer-first culture, joining its board to support its vision.
- Costco’s consistent growth, strong returns, and growth in global markets and eCommerce secured Munger’s long-term commitment.
A World-class Business Model
Munger’s thesis on Costco began with the company’s strict discipline in providing value to customers by passing its own purchasing power advantages through to them.
This practice has helped Costco create immense customer loyalty and build a massive base of members paying fees on which the company realizes high margins. Costco’s reputation for low pricing is so great that Munger even argued it could become a challenger to Amazon as it moves into eCommerce.
This loyalty has translated into very real results for Costco with existing members renew their memberships at rates exceeding 90%. Membership fees alone generated $4.83 billion in revenue in the fiscal year ending on September 1st, up 5.5% from the $4.58 billion generated last year. As of the end of last year, Costco had more than 125 million members worldwide.
Costco has also essentially become a one-stop shop where customers can buy much more than groceries, clothes, furniture and other daily essentials.
An excellent example of this is the company’s automotive sales program, which now moves more than half a million vehicles each year. For reference of scale, Carvana, an innovative and fast-growing company specializing exclusively in used car sales, has taken 11 years to reach 4 million cars bought and sold.
This is just one of many examples of how Costco can leverage its enormous and fiercely loyal existing member base to drive sales in new categories that one wouldn’t normally associate with big-box retail.
A final note on Costco’s business model that likely appealed to Munger is how well it navigates poor market climates. Costco’s ability to offer superior value to customers actually tends to increase its appeal during recessions and periods of high inflation.
Between these facts and its incredible ability to build and retain members, Costco clearly enjoys the all-important competitive moat that Charlie Munger famously looked for in his investments.
Costco’s Leadership Checked a Box For Munger
Beyond looking for excellent business models, Munger was also a believer in finding companies run by great management teams. Costco again ticked this box on Munger’s investment wishlist.
Indeed, the investor’s connection to Costco’s management ran so deep that he earned a seat on the company’s board and remained on it until his passing in 2023.
Munger credited management and Costco’s internal culture with producing high loyalty among the company’s customer base. Specifically, he argued that Costco had self-imposed what amounted to an ethical commitment to passing its own advantages in buying power on to its customers.
This kind of thinking on management’s part can still be seen today. For example, earlier this year the company decided to delay an increase in membership fees to avoid adversely affecting customers who were already being strained by rising costs elsewhere.
He also praised the meritocratic nature of the company. Costco is well-known for compensating its workers well in order to drive top tier service for its customers. Following a recent round of wage increases, Costco’s average hourly pay for its workers across all positions was over $30.
The company’s internal minimum wage is $19.50, making it among the highest-paying retailers for new hires. Costco also promotes from within an impressive 98% of the time.
Ironclad Investment Fundamentals
Though Munger leaned earlier into paying premium prices for great businesses than Warren Buffett, Costco may have been the ultimate test of his willingness to stick with stocks that would otherwise appear to be overvalued.
While Munger acknowledged the fact that Costco shares often looked expensive, he maintained his position that they were a strong long-term investment and famously said that he never even thought of selling a share.
Behind Munger’s total adherence to seemingly expensive Costco shares was the company’s exceptional financial performance. In 15 years, the company hasn’t experienced a single quarter of negative year-over-year revenue growth.
Net incomes, likewise, have followed a more or less straight line trajectory upward over many years. In 2014, the company’s full fiscal year net income was about $2.13 billion. The most recent trailing 12-month number was $7.37 billion.
Return on equity has been another very strong suit for Costco over the years. In the last decade, Costco’s ROE has never dipped below 17%. Moreover, the company has managed to keep its ROE moving gradually higher over the years.
In 2014, Costco generated a return of 17.5% on equity while for the trailing 12-month period ending in September 2024, the return had risen to 31.9%.
Of course, Munger’s elevated bullishness on Costco also took into account its long runway for further growth. As of the end of the fiscal year, the company had 891 warehouse stores, of which 614 were in the United States. While there is certainly still room for growth in the US, international markets may offer even larger opportunities. Of particular note is the Chinese market where Costco has a mere seven stores.
As Munger predicted, Costco has also begun to make significant inroads into eCommerce. In fiscal Q4, the company’s online sales grew by almost 19% year-over-year, roughly tripling the rate of overall sales growth. Though the company was initially slow to join the online sales trend, its decision to invest more heavily in eCommerce appears to be producing admirable results.