When you're dealing with a rapidly growing retailer like Costco (NASDAQ: COST), the factors that are likely to cause its stock to rise aren't rocket science. They all have to do with the nuts and bolts of running a successful retail operation. In Costco's case, these consist of adding more members, building more stores, and increasing sales at existing stores.

1. More members
If you want to understand Costco, it's first necessary to appreciate how unique its business model is. Most retailers look to the profit they earn on selling goods and services to pad the bottom line. However, Costco bypasses these profits and instead gives its members lower prices. The only thing left over for shareholders is the amount of money the chain of discount warehouses earns from membership fees. Costco charges $55 a year for the Gold Star membership that suits most households. Executive membership, which includes a 2% reward on purchases, costs $110 per year.

Over the past three years, Costco has generated total revenue of $317 billion, of which $6.8 billion consisted of membership fees. Its profit over the same time period was $5.8 billion. It stands to reason, in turn, that the main way Costco will increase its earnings, and thereby its share price, is to increase the size of its membership base.


This won't be hard. As an initial matter, most people who sign up for an annual membership continue to renew it. According to Costco's 2014 annual report, U.S. and Canadian members renewed at a 91% rate last year, and its worldwide renewal rate topped 87%. Additionally, average annualized first-year sales at new locations, which reflects a growing membership base, was a record $108 million for the 12 months ended Aug. 31, 2014.

2. More stores
Even though Costco is already the second-largest retailer in the United States, it still has considerable room to grow. In the 2014 fiscal year, it opened 17 new locations in the United States, each of which, as noted above, generated average annual sales of $108 million. This included the company's first stores in both South Dakota and Louisiana -- it's now in 43 states.

Costco also expanded abroad by opening 13 stores in international markets. This continued its global expansion with new warehouses in seven countries: Mexico, Canada, Australia, Japan, Korea, the United Kingdom, and Spain (the company's first warehouse there).

Its plan for the current year is to open up to 31 new warehouses net of relocations. Planned openings include 20 in the United States, four in Mexico, three in Japan, two each in Australia and Korea, and one each in Canada, the U.K., and Taiwan. All told, this will increase its warehouse square footage by 5% and bring its total until count to just under 700 locations.

3. More sales per store
Finally, in addition to increasing its store count and membership base, the most effective way for Costco to boost its sales and earnings, and ultimately its stock price, is to increase sales at existing locations. Known in the industry as same-store, or comparable, sales, this is one of the most important metrics for retailers.

Some of this growth will occur naturally as sales at its existing locations continue to season. You can see this in the chart below, which shows the average sales per Costco warehouse based on the year they were opened. For example, the average sales per warehouse opened in 2014 was $108 million compared to $144 million for stores opened in 2010.


The remainder of organic growth will stem from Costco's relentless efforts to lower prices and acquire great merchandise. "Great merchandise at exceptional prices is what our members around the world expect to find at Costco," Chairman Jeff Brotman and CEO Craig Jelinek wrote in their latest letter to shareholders.

To this end, in 2014, Costco added products from Cole Haan Outerwear, Rachel Zoe, Nespresso, Ike Behar, All-Clad Cookware, Shiseido, and a range of Apple products to its merchandise mix. It also expanded its offerings of organic products in order to "[keep] pace with the movement toward healthier lifestyles," which generated sales of nearly $3 billion. Finally, it's begun to selectively add natural and gluten-free foods to its assortment of products.

In sum, because Costco has multiple levers it can pull, there's every reason to believe that, over the long run, its shares will continue to head higher.

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John Maxfield has no position in any stocks mentioned.

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