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Costco should weather tough economic times

Universal Press Syndicate

Costco (Nasdaq: COST) reinforced what we already knew when it gave a negative second-quarter forecast recently. Things are pretty bad out there, and no retailer’s immune.

The warehouse discounter disclosed that second-quarter earnings will be “substantially below” analyst estimates. Chief Financial Officer Richard Galanti pointed to general economic conditions pinching sales and said sales of non-food merchandise have been challenging. So the difficult economic climate has also hurt merchandise margins.

None of this is really that surprising, since there were similar tidings in last quarter’s results. One difference last quarter was that Costco was helped by gasoline profitability.

Meanwhile, it’s no secret that consumers are really reining in their spending, because of fear or necessity. This bodes well in some ways for discounters, but at the same time, retail in general is struggling.

Costco’s recent price drop presents a good opportunity. It’s a company with a great business model and an impressive management team, and its mission to provide low-priced wares makes it one of the retailers that should be able to do well despite the economy. It’s also got manageable debt levels and cash on the balance sheet. The current environment is not the end of the world for Costco.

Ask the Fool

Q: What’s a “payout ratio”? – R.B., Hartford, Conn.

A: It’s the percentage of a company’s earnings (net income) paid out to shareholders as a dividend. For example, McDonald’s is expected to earn approximately $3.82 per share in fiscal 2009, and its annual dividend amount is currently $2. Divide $2 by $3.82 and you’ll get 0.52, or a payout ratio of 52 percent.

High payout ratios leave companies with little flexibility regarding what they can do with their cash. That can be OK, if a firm is big and established and doesn’t need to reinvest much in the business. Sometimes reinvested earnings would return less than shareholders could get investing the payout on their own.

Steep payout ratios can be red flags. If a company’s ratio is 125 percent, for example, it will have to dig into reserves to pay its dividend, something it can’t keep up forever. It may have to reduce its dividend.

To see our list of recommended dividend-paying stocks, try our Motley Fool Income Investor newsletter for free at newsletters.

Q: Do I need life insurance? – T.N., Reno, Nev.

A: If you’re young and debt-free, with no children and no house, you might consider skipping it – for now. Think of insurance as protection against a financial loss, not as an investment. (After all, there are more effective ways to invest.) If a spouse or children depend on your income, carrying insurance would be smart, to protect against income loss, should something happen to you. But if you don’t need to protect any income stream, consider parking your money elsewhere. (Learn about better investment strategies at basics/index.aspx.)

Still, do take some time to read up on insurance – at and

My dumbest investment

My dumbest investment was loading up on Freddie Mac back in September, when it was going up for a brief period. My next dumbest moves were not following the news on the company after having purchased the stock and holding on to it for too long. Needless to say, I found out about the government takeover when it was too late for me to sell out, so I hopelessly watched myself lose thousands and thousands of dollars in a matter of seconds as the price quickly dropped from around $5.10 a share to around a $1 a share, where I finally sold. – Mike, Centreville, Va.

The Fool responds: At least you sold then – last time we checked, the stock was trading for considerably less than $1 per share. Many people mistakenly think that a stock that has fallen far can’t fall much more. About a year before you bought into Freddie Mac, it was trading in the $60s. Remember that if a company has dropped sharply, something is going on and needs your attention. Such holdings should be followed closely and are often best just avoided altogether.

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