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Warren Buffett rarely gives advice about stocks to buy. But at the 2000 Berkshire Hathaway Annual Meeting, the former CEO did give one name as a standout for investors to consider.
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.
