Measuring Up: Wal-Mart Versus Target

Wal-Mart or Target? That is the question. The fact is that Wal-Mart is much bigger. But Target is closer to my house. Consequently Target ends up getting more of my business. But what about when it comes to money? Which is the better investment? Are you better off shelling out your hard-earned cash on a few shares of Wal-Mart (NYSE: WMT  ) ? Or is Target (NYSE: TGT  ) the bull's-eye for your portfolio? By taking a look at a few common ratios over time, we can certainly get a better idea as to which company may be the better bet.

Return on equity
Warren Buffett likes looking at a company's return on equity because it is a key indicator of how profitable the business is as well as how well the company's assets and leverage are being managed. Think about it this way: A company earning $1 million in a given year on $5 million in shareholder's equity is doing a better job than another company earning $1 million on $20 million in shareholder's equity. This is what return on equity tells us. So how do Wal-Mart and Target measure up here? Let's take a look:

 

TTM

2010

2009

2008

2007

5-Year Average

Wal-Mart

22.5%

21.2%

20.4%

20.4%

21.2%

21.1%

Target

18.2%

17.1%

15.3%

18.4%

18.7%

17.5%

Source: Capital IQ, a division of Standard & Poor's.

Based on the five-year averages here, Wal-Mart has the edge. Though both companies are smoking Costco's (Nasdaq: COST  ) 12.5% average.

Operating margin
When we talk about margins, a good one to focus on is the operating margin, also known as the EBIT margin (earnings before interest and taxes). These are the earnings that take into account the company's operating expenses, and this can tell us how much the company is spending to operate the business. I mean let's face it, earning $1 million isn't going to mean much if it costs you $950,000 to do it. So how do these two compare? Here are the figures:

 

TTM

2010

2009

2008

2007

5-Year Average

Wal-Mart

6.1%

6%

5.7%

5.9%

5.9%

5.9%

Target

7.5%

7.1%

6.8%

8.3%

8.5%

7.6%

Source: Capital IQ, a division of Standard & Poor's.

Target is making up ground in the overall standings when it comes to EBIT margins.

Free cash flow margin
Finally, I like to take a look at the free cash flow margin. While slightly more involved, it can really shed light on what the company is actually making once it is all said and done. Free cash flow is one of our favorite numbers to look at. Simply defined as cash flow from operations less capital expenditures, free cash flow is that money that is left after all of the bills have been paid. It is the money that the company can return to shareholders in one fashion or another. Be it in the form of dividends, share buybacks or even reinvesting in the business. The free cash flow margin is a comparison of the free cash flow the company is generating to its revenues. Let's see how the two match up:

 

TTM

2010

2009

2008

2007

5-Year Average

Wal-Mart

3.5%

3.5%

2.9%

1.5%

1.3%

2.5%

Target

6.1%

6.6%

1.4%

-0.4%

1.6%

3.1%

Source: Capital IQ, a division of Standard & Poor's.

Target squeaks one out over Wal-Mart, but it's a close one!

And the winner is ...
All things being equal, when we consider these three metrics in assessing both businesses, I give Target the edge here. Granted, the company doesn't match Wal-Mart's returns on equity. But Target sure makes up for it with better operating and free cash flow margins. While these aren't the only metrics to consider when assessing a business, they can provide a good starting point for further research. To be sure, both are quality businesses and worthy of consideration. But on this day, Target is the Foolish winner.

Inside Value analyst Jason Moser owns no shares of any companies mentioned in this article. Costco and Wal-Mart are Motley Fool Inside Value recommendations. Costco is a Motley Fool Stock Advisor pick. The Fool owns shares of Costco and Wal-Mart. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


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