Costco Wholesale Corporation (COST),, Inc. (AMZN): A Regular Fool’s Retirement Portfolio, Retail

Page 1 of 2

Changes in the retail landscape are creating powerful opportunities for investors. And as someone who’s still years from retirement, I’m looking to capitalize on these trends. The companies below are all part of my retirement portfolio, and could be great investments for you, too.

The future of retail

Consumer behaviors have shifted over the past decades. We have learned that the internet is a great place to do business, and how the quality of the food we consume affects the world around us as much as it affects our bodies. We have also learned that the best operators sometimes pass along their cost savings to the customers as well. Let’s start with this last part, first.

The loyalty factor

Costco Wholesale Corporation (NASDAQ:COST)

Costco Wholesale Corporation (NASDAQ:COST) derives the bulk of its income from membership fees. Through Q3 of the current FY, it has generated $2.1 billion in operating income on $72.6 billion in sales. And when the cost of merchandise and SG&A (basically operations costs) is over $70 billion, it’s pretty clear how important Costco Wholesale Corporation (NASDAQ:COST)’s $1.57 billion in membership fees is to the company’s bottom line.

It’s important to note that Costco Wholesale Corporation (NASDAQ:COST)’s operating margin, near 3%, is very low compared to industry peers. The company does this deliberately, promising to pass cost-savings along to members; its gross margin is anywhere from one-half to one-third that of competitors like Wal-Mart Stores, Inc. (NYSE:WMT) and Target Corporation (NYSE:TGT).

With membership renewal rates near 90% (around 86% internationally,) members clearly are “buying” Costco Wholesale Corporation (NASDAQ:COST)’s promise for low prices. Factor in a high single-digit growth rate and a small dividend that the company will grow over time, and this is a strong long-term investment.

The cheap, easy and convenient factor, Inc. (NASDAQ:AMZN) has changed the way we think about buying. Once the go-to online bookseller, it has branched out into nearly every retail purchase imaginable. While the battle rages on between those who think the company is insanely valued, and those who think it’s just getting started, there is one thing we can all agree on:, Inc. (NASDAQ:AMZN) will keep selling us more and more stuff every year, for years to come.

The question on many investors’ minds: “At what point will revenues start to turn into profits?” Both free cash flow and net income have been moving down as the company plows every dollar it can back into expansion. It’s important to remember that this expansion is all-important right now. Without it,, Inc. (NASDAQ:AMZN) would become a victim of its own success and unable to meet demand.

There is also concern that, Inc. (NASDAQ:AMZN) sells too many things at a loss. I’ve heard everything from the Kindle Fire, to Prime — both its shipping and free streaming content — to its more recent expansion into groceries, all described as “loss leaders” that will draw customers to more expensive and profitable items. Eventually, it has to sell something for a profit!

I think the “loss leader” strategy is a bit overstated. It has become a talisman as the easy explanation for its latest expansions. The reality is, all of these expansions could generate serious cash in the future. And when free cash flow starts consistently growing faster than capital expenditures, the cash flow faucet could turn into a real gusher.

Page 1 of 2