Why Is Costco Stock Not Going Up?

There is an old rule in the stock market that when a company raises prices and enjoys pricing power, it bodes well for shareholders because margins and profits will rise.

You would think then that when Costco decided it would hike price on all 52 million members this week that the market would respond with enthusiasm.

Yet Costco share price fell on the news, a real U-turn versus the normal consensus expectations. So why did Costco stock not react favorably for the bulls?

Costco Price Hike Was A Long-time Coming

When Costco did hike prices, every member got stung with the increase. For the majority of members on the Gold Star plan, the annual price rose by $5 to $65 while the Executive tier went up by double that, a full $10, to $130 per year.

These increases were a long time coming. It’s been years since Costco pushed through a price increase on its members, all the way back to 2017, in fact.

And in that time window, something jumps out at us that should be factored in by investors who have an eye on the long-term. While it’s been 7 years since the last increase, the amortized price increase per year is about $0.80 for Gold members and closer to $1.60 for Executive members.

So while members are unlikely to see price increases every year, shareholders can likely assume that when they do come they will be bundled into one fee hike.

The reason Costco doesn’t increase by close to $1 per year but instead chooses $5 all at once is likely down to a behavioral theory called Prospect Theory.

Essentially, that theory postulates that we humans like to integrate losses and segregate gains. Or in other words we like good news spread out over time and bad news to hit us all at once. 

One way to test this out is to give flowers to your loved one, and soon you will find most likely that a flower day brings greater joy than one bunch given all at once.

When it comes to costs, we often prefer something similar. We prefer paying an annual fee versus a monthly one, and Costco leadership may just have uncovered that the same goes with price hikes annually versus every half decade or so.

In short, better to hit members with a single large price hike infrequently than a smaller one consistently each year.

If you are a Costco shareholder, though, these amortized annual price hikes can likely be anticipated even if they don’t get announced annually.

The bigger question is why did this move, which almost inevitably will lead to higher margins and profitability lead to a selloff to the tune of about 5% over the following 48 hours?

Is The News Baked In?

While new Costco shareholders today may think they are “on to something” having spotted Costco’s infrequent but chunky membership price hikes, longer term shareholders already know how the game is played.

And the reason the shares didn’t pop isn’t because the news came as a surprise but rather that it was anticipated and they had likely expected a bigger fee hike.

With inflation running rampant these days, Costco’s price hike of less than $1 a year is nowhere near in line with the CPI or the rate of increase of just about any other day-to-day item consumers purchase.

Arguably, shareholders should not have been surprised by the $5 hike because that’s in line with all prior increases but usually management doesn’t wait a full 7 years to increases prices. In fact, it would have been very much in line with inflationary norms had they chosen to increase at the pace of $1 per year, or $7 total. 

Perhaps there is some deeper psychology to favor a round number like $65 versus $67. No doubt, Costco with its deep pockets conducted research to investigate the merits of increasing by $5 versus $7 or even $10.

So, why is Costco stock not going up? The short answer is long-term shareholders had already discounted management’s membership price hike and were disappointed it wasn’t more.

Why Does Costco Not Hike Prices More?

While Costco failed to keep investors fully satisfied with the price hike, members are likely thrilled to not have been stung with an even higher fee at a time when most every other grocery-related product is soaring in price.

And therein lies the tradeoff for Costco management. Keeping members and shareholders pleased simultaneously is quite the balancing act. 

Had they chosen a higher fee hike, the odds increase of churn rising, meaning more people are likely to cancel their memberships. That churn figure sits at about 7% right now.

It seems somewhat incidental at first glance to focus on the membership fee that only brings in about $3 billion or less than 3% of the company’s gross annual revenues.

But those membership fees represent over 50% of the firm’s profits, meaning small changes in membership pricing dramatically changes operating profits.

On the whole, it’s more important to keep customers, who pay the bills, happy than shareholders who may be more fickle. If Costco could trade a long-term shareholder for a long-term customer, they probably would do so all day long because the value of the business is directly tied to the longevity and lifetime value of customers.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.