Ratio analysis
Costco’s net profit margin for the year 2014 was 1.83% implying that it earned a net income of $0.0183 for each dollar of total revenue. The ratio increased from 1.72% in 2012 to 1.94% in 2013 before declining to 1.83% in 2014. Return on total assets also grew from 6.3% in 2013 to 6.73% in 2013 before falling to 6.23% in 2014. The company’s return on equity was 16.73% in the year 2014. In 2012, return on equity was 13.83%. The ratio increased in 2013 to 18.82%. The above ratios indicate the profitability of Costco increased in 2013 but declined in 2014 (Gibson 451).
Costco’s current ratio was 1.22 implying that its current assets were more than its current liabilities. The ratio increased from 1.1 in 2012 to 1.19 in 2013. The quick ratio also increased from 0.52 in 2012 to 0.60 in 2013. In 2014, it increased further to 0.63. Therefore, Costco was liquid for the three years under consideration. The increase in ratios throughout the period from 2012 to 2014 indicates that the liquidity of Costco improved during the period (Gibson 451).
In the year 2014, Costco’s total debt ratio was 0.63 showing that it acquired 63% of its total assets through borrowing. The ratio increased from 0.54 in 2012 to 0.64 in 2013 before falling to 0.63 in 2014. The debt-equity ratio also increased from 1.2 in 2012 to 1.80 in 2013 then fell to 1.68 in 2014. Interest cover was 29.29 times indicating that the company’s EBIT was 29.29 times its interest expense hence it was able to pay its interest obligations. Interest cover increased from 30.13 in 2012 to 31.82 in 2013. The trend of total debt and debt-equity ratios indicate that the solvency of Costco declined in 2013 then increased in 2014 (Gibson 451).
Costco’s earnings per share increased from $3.94 in 2012 to $4.68 and $4.69 in 2013 and 2014 respectively. This shows an increase in the return to shareholders during the three years.
Free cash flows
Costco had positive free cash flows during all the three years under consideration. In 2013, the free cash flow was $5,755,214, and this increased to $8,518,124 in 2013. In 2014, the free cash flow declined to $8,073,198. The presence of positive free cash flows implies that the company has adequate cash to finance capital projects and to exploit both planned and unexpected opportunities (Brigham and Ehrhardt 439). Free cash flow is important for the company’s growth hence Costco has the ability for growth.
Non-financial factors
Costco operates in a highly competitive market. It faces stiff competition from other stores like Wal-Mart, Lowes, among other firms. Stiff competition may affect the profitability of the company thus reducing the return to its shareholders. The company’s management is effective, and this has contributed to the company’s success. The continuing growth of the population presents opportunities for the company to increase its revenues since most of its products are essential commodities.
Estimate of the required rate of return
According to Yahoo Finance, the Beta for Costco’s stock is 0.73. The risk-free rate (Yield on 10 YR US T-Bills) was 2.52% on 17th April, 2015 (Yahoo! Finance). Assuming an Equity Risk Premium of 5.75%, the required return on the stock of Costco is 4.878%.
Actual return on the stock
This part assumes that an investor held the stock of Costco for one year from April 17, 2014 to April 17, 2015. The total dividends declared throughout the period were $6.42. The market price of the stock on April 21, 2014 was $109.22 while the price on April 17, 2015 was $144.57. The actual return was 38.42%. The actual return on the stock was more than the required return determined in the previous section above. This implies that the stock generates more than the expected return.
Recommendation
I would recommend buying and holding the stock of Costco. The company is profitable as indicated by the profitability ratios. The liquidity ratios also indicate that Costco has sufficient current assets to pay its current liabilities. The solvency ratios show that Costco is solvent and does not face a significant risk of liquidation. In addition, the interest cover implies that its earnings are adequate to cover its interest obligations. Earnings per share and dividend per share ratios show that Costco gives value for shareholders’ money. Therefore, an investor will gain if he buys and holds the stock.
Works cited
Brigham, Eugene F, and Michael C. Ehrhardt. Financial Management: Theory & Practice. 14th ed. Mason, Ohio: Cengage Learning, 2013. Print.
Gibson, Charles H. Financial Reporting And Analysis: Using Financial Accounting Information. 11th ed. Cincinnati, Ohio: South-Western College Pub., 2008. Print.
Yahoo! Finance,. 'Costco Wholesale Corporation'. N.p., 2015. Web. 19 Apr. 2015
