How appropriate are the five factors that Torres chooses to determine the future performance of Costco?

What other relevant factors might be included in a forecast of the business? To what extent are they covered in the factors above?

the company's operational success. During the years 1992 to 1995 , the company's stock price corrected itself to be more in line with reasonable valuations, and investors who held it from peak to trough saw a loss of 70 percent in their investment. This was also the time of the CostcoPrice Club merger, which caused short-term disruptions in operations. By the late 1990 s, the company regained steam operationally, and the price of the stock increased almost ten-fold by May of 2000 . By July 2002 , the stock was off its all-time high, trading at around $35 per share. Investors who put $1,000 in Costco stock at the time of its IPO saw their holdings grow to $21,000 by July 2002 , a compounded return of over 19 percent per year for almost 17 years. The company's stock traded on the NASDAQ under the symbol COST. FORECAST To determine a financial forecast for Costco, Torres went through the following four-step process: 1. She listed the fundamental factors that would drive growth. Keeping in mind Albert Einstein's statement that "things should be made as simple as possible but not any simpler," she set an objective of isolating the four or five drivers that had the largest impact on Costco's future. She considered the constraints associated with each factor. 2. Second, she forecasted Costco's income statement and computed a rough estimate of free cash flow based on her determinations in step one. 3. Third, she ran a quantitative check on the numbers, comparing key ratios to the historical results to consider the feasibility of her projections. 4. Fourth, she ran a qualitative check on the numbers to understand whether her projections were conservative or aggressive. In carrying out her analysis, she relied on diverse sources of information: industry reports such as those compiled by Standard and Poor's, research analyst reports, web casts with company management archived on the investor relations section of company websites, and business periodicals. Growth Drivers The first factor she considered was the number of warehouses that the company would operate in the U.S. She had read in business periodicals that analysts thought the saturation point in the U.S. market was 1500 warehouses shared among all competitors. Costco management, in its third quarter 2002 conference call with analysts, said that it expected to operate between 500 and 600 stores in the U.S. by 20101. Management considered 500 conservative, 580 assertive, and 600 aggressive. With 289 U.S. warehouses in 2002, Costco had approximately a 30 percent market share. Torres knew that there was intense competition among Costco, SAM'S, and BJ's ' Forward-looking comments made by management, here and throughout the case, taken from: Costco Wholesale Corporation, "Audio Events: Q3 2002 Costco Wholesale Corporation Earnings Conference Call," May 30,2002 , to expand in the U.S. SAM'S had announced plans to aggressively increase its own new store openings. The second factor she considered was sales per store. In more established warehouses, Costco had U.S. sales per store of approximately $100 million, compared to $60 million for SAM'S, and $45 million for BJ's. All three companies felt that fresh food, luxury items such as fine wines and jewelry, and ancillary products helped to increase same-store sales over time. Costco management had stated that they would like to get U.S. store sales up to $125 million or even $150 million per store. Was that possible? Also, with the companies increasingly entering each other's markets, what pressure would be placed on Costco's store sales? Which company, if any, would come out dominant? The third important growth driver was the membership base. Costco located warehouses in areas with a population of around 500,000 in a 15 -mile radius. They expected to sign up approximately 10 percent of those people as members. Torres was not sure whether membership per store would increase or decrease, especially given the effects of competition. She did feel, however, that Costco could raise the membership fee over time. The basic annual membership fee was $25 in the mid-1980s. By now it was $45. Costco also had an executive membership, which was $100. She felt that as customers spent more money on sales merchandise, the more valuable they would perceive the membership to be and the more, in turn, Costco could charge. Costco management reported that recent increases in the membership fee did not materially change membership renewal rates, which average 86 percent. The fourth important factor to consider was operating margins. Costco management had recently stated that they felt they deserved to make more money from their business, given the value they delivered to customers. Management noted that pretax margin had peaked at 3.3 percent in 2000 and fell to 2.9 percent in 2001 . Costco wanted to increase their pretax margin to 3.4 percent to 3.6 percent over the next five years (Wal-Mart's pretax margin was almost 6 percent). Torres did not know how much of this increase would come from improved gross margin, resulting from a change in pricing strategy, and how much from improved operating margins, where operations were already very efficient. The fifth main factor she considered was international expansion. Management had already stated that its emphasis was on U.S. growth, but that it would grow internationally where it felt it could do so profitably. Plans were to open four to eight warehouses per year internationally over the next five years, and 10 to 15 per year over the subsequent five years. Forecast Financial Statements The next step was to forecast the financial statements based on her assumptions about the five main growth drivers, using 2010 as a terminal vear She built the model in the following steps: the company's operational success. During the years 1992 to 1995 , the company's stock price corrected itself to be more in line with reasonable valuations, and investors who held it from peak to trough saw a loss of 70 percent in their investment. This was also the time of the CostcoPrice Club merger, which caused short-term disruptions in operations. By the late 1990 s, the company regained steam operationally, and the price of the stock increased almost ten-fold by May of 2000 . By July 2002 , the stock was off its all-time high, trading at around $35 per share. Investors who put $1,000 in Costco stock at the time of its IPO saw their holdings grow to $21,000 by July 2002 , a compounded return of over 19 percent per year for almost 17 years. The company's stock traded on the NASDAQ under the symbol COST. FORECAST To determine a financial forecast for Costco, Torres went through the following four-step process: 1. She listed the fundamental factors that would drive growth. Keeping in mind Albert Einstein's statement that "things should be made as simple as possible but not any simpler," she set an objective of isolating the four or five drivers that had the largest impact on Costco's future. She considered the constraints associated with each factor. 2. Second, she forecasted Costco's income statement and computed a rough estimate of free cash flow based on her determinations in step one. 3. Third, she ran a quantitative check on the numbers, comparing key ratios to the historical results to consider the feasibility of her projections. 4. Fourth, she ran a qualitative check on the numbers to understand whether her projections were conservative or aggressive. In carrying out her analysis, she relied on diverse sources of information: industry reports such as those compiled by Standard and Poor's, research analyst reports, web casts with company management archived on the investor relations section of company websites, and business periodicals. Growth Drivers The first factor she considered was the number of warehouses that the company would operate in the U.S. She had read in business periodicals that analysts thought the saturation point in the U.S. market was 1500 warehouses shared among all competitors. Costco management, in its third quarter 2002 conference call with analysts, said that it expected to operate between 500 and 600 stores in the U.S. by 20101. Management considered 500 conservative, 580 assertive, and 600 aggressive. With 289 U.S. warehouses in 2002, Costco had approximately a 30 percent market share. Torres knew that there was intense competition among Costco, SAM'S, and BJ's ' Forward-looking comments made by management, here and throughout the case, taken from: Costco Wholesale Corporation, "Audio Events: Q3 2002 Costco Wholesale Corporation Earnings Conference Call," May 30,2002 , to expand in the U.S. SAM'S had announced plans to aggressively increase its own new store openings. The second factor she considered was sales per store. In more established warehouses, Costco had U.S. sales per store of approximately $100 million, compared to $60 million for SAM'S, and $45 million for BJ's. All three companies felt that fresh food, luxury items such as fine wines and jewelry, and ancillary products helped to increase same-store sales over time. Costco management had stated that they would like to get U.S. store sales up to $125 million or even $150 million per store. Was that possible? Also, with the companies increasingly entering each other's markets, what pressure would be placed on Costco's store sales? Which company, if any, would come out dominant? The third important growth driver was the membership base. Costco located warehouses in areas with a population of around 500,000 in a 15 -mile radius. They expected to sign up approximately 10 percent of those people as members. Torres was not sure whether membership per store would increase or decrease, especially given the effects of competition. She did feel, however, that Costco could raise the membership fee over time. The basic annual membership fee was $25 in the mid-1980s. By now it was $45. Costco also had an executive membership, which was $100. She felt that as customers spent more money on sales merchandise, the more valuable they would perceive the membership to be and the more, in turn, Costco could charge. Costco management reported that recent increases in the membership fee did not materially change membership renewal rates, which average 86 percent. The fourth important factor to consider was operating margins. Costco management had recently stated that they felt they deserved to make more money from their business, given the value they delivered to customers. Management noted that pretax margin had peaked at 3.3 percent in 2000 and fell to 2.9 percent in 2001 . Costco wanted to increase their pretax margin to 3.4 percent to 3.6 percent over the next five years (Wal-Mart's pretax margin was almost 6 percent). Torres did not know how much of this increase would come from improved gross margin, resulting from a change in pricing strategy, and how much from improved operating margins, where operations were already very efficient. The fifth main factor she considered was international expansion. Management had already stated that its emphasis was on U.S. growth, but that it would grow internationally where it felt it could do so profitably. Plans were to open four to eight warehouses per year internationally over the next five years, and 10 to 15 per year over the subsequent five years. Forecast Financial Statements The next step was to forecast the financial statements based on her assumptions about the five main growth drivers, using 2010 as a terminal vear She built the model in the following steps