1 Retailer to Stock Up On This Christmas

Costco Wholesale is a national retail chain that aims to sell a high volume of home items, food, apparel, and other consumer goods. That's about where its similarities to big retailers like Target and Wal-Mart stop. Costco doesn't offer the variety of brands that its big peers do, nor does it have as many locations. In fact, Costco might be more noticeable for what it doesn't have than what it does.

Right away, a shopper notices that Costco doesn't have floor treatments, just concrete slabs. No glossy displays, just the wooden pallets the goods were brought in on. There aren't even sales at Costco. No coupons, discounts, 2-for-1 deals, or holiday specials.

There's also no advertising budget. No television commercials, radio jingles, ads in newspapers, nothing. Lacking, too, are signs. Want to find the toilet paper? Well ... walk around. You'll find it. And maybe a few other great deals you just can't pass up on the way.

Anything else missing? Big price markups. Costco is dedicated to keeping prices low, pushing merchandise costs down from its suppliers, and passing the savings directly to shoppers. But while Costco goes through great lengths to keep prices low for its customers, the inevitable result is low gross margins. How can Costco's customer-driven focus benefit investors, too?

At under 11%, Costco's gross margin looks pretty weak compared to Wal-Mart's 25%, Staples' 27%, and Target's 30%. Costco is different from other retailers in a lot of ways, and for Costco investors one of the most important things to keep in mind is that high gross margins aren't a good sign. Costco actually aims to keep margins low, so customers will be satisfied that they're getting a valuable service.

And I do mean "service," not "product." A better way to think about Costco's business model is less like a traditional retailer, earning a profit on goods sold, and more like a subscription service, earning a profit on annual member fees that customers pay to shop there. These membership fees made up only 2% of total revenue in 2012, but accounted for 77% of operating income. For the bottom line, Costco's concerns look a lot more like a magazine's than a retailer's: subscriber renewal rates, subscriber growth, and subscription fee increases.

The key to Costco's success is fanatical customer loyalty. Happy shoppers not only directly support shareholder returns by paying membership fees, they also serve as Costco's best advertisers. So far, Costco's stunning 86% renewal rate in 2012, even after a price hike in annual fees, shows that members are happy with Costco.