Cotsco
Sustainable Growth Model
Step 1: Profitability and Earnings Retention
At the end of each year the return that Costco realizes on equity capital can either be reinvested back into the business or paid out to investors as dividends and common stock repurchases. If no dividends or share repurchases were made and earnings were reinvested back into the business at the same incremental rate of return, the company's return on equity would hold constant over time.
In reality, most companies, including Costco, frequently experience changes in their return on equity, and distribute some portion of earnings to investors.
Therefore, at the highest level, sustainable growth rate for Costco and its competitors can be expressed as the product of the following two ratios:
∑ Earnings Retention Ratio = 1 - Dividend Payout Ratio
∑ Return on Equity (ROE) = Net Income / Owner's Equity
As demonstrated in the accompanying tables, Costco retained all of their earnings for the periods 1997 through 2001 so their dividend payout ratio is 0 and its earning retention ratio is 1. This means that Costco Corp. retain 100% of earnings therefore paying out 0% in dividends, which is indicative of rapidly expanding company.
Return on equity is an overall measure of performance of a company because it measures how much profit is generated in net income for every dollar invested in equity capital. Good companies typically have equity values from 15% to 25%. Costco's ROE has changed up and down over the past five years, in 1998 at 18.6% and the lowest was 2001 at 14.2%. Costco's ROE has maintained near 15% from 1998 to 2000 which indicates consistent company performance except for year 2001 as Costco opened 41 warehouse which increase the operating expenses.
Although Costco's ROE has been slightly lower than the minimum value of a good company in 2001, it has not changed as much as it's major competitors. After multiple years of ROE near 30%,
Step 1: Profitability and Earnings Retention
At the end of each year the return that Costco realizes on equity capital can either be reinvested back into the business or paid out to investors as dividends and common stock repurchases. If no dividends or share repurchases were made and earnings were reinvested back into the business at the same incremental rate of return, the company's return on equity would hold constant over time.
In reality, most companies, including Costco, frequently experience changes in their return on equity, and distribute some portion of earnings to investors.
Therefore, at the highest level, sustainable growth rate for Costco and its competitors can be expressed as the product of the following two ratios:
∑ Earnings Retention Ratio = 1 - Dividend Payout Ratio
∑ Return on Equity (ROE) = Net Income / Owner's Equity
As demonstrated in the accompanying tables, Costco retained all of their earnings for the periods 1997 through 2001 so their dividend payout ratio is 0 and its earning retention ratio is 1. This means that Costco Corp. retain 100% of earnings therefore paying out 0% in dividends, which is indicative of rapidly expanding company.
Return on equity is an overall measure of performance of a company because it measures how much profit is generated in net income for every dollar invested in equity capital. Good companies typically have equity values from 15% to 25%. Costco's ROE has changed up and down over the past five years, in 1998 at 18.6% and the lowest was 2001 at 14.2%. Costco's ROE has maintained near 15% from 1998 to 2000 which indicates consistent company performance except for year 2001 as Costco opened 41 warehouse which increase the operating expenses.
Although Costco's ROE has been slightly lower than the minimum value of a good company in 2001, it has not changed as much as it's major competitors. After multiple years of ROE near 30%,