Image source: Getty Images.

Since the depths of the Great Recession, shares of Costco (COST -0.82%) and Target (TGT 0.43%) have had very different fates. Whereas Target (after including dividends) is actually losing to the S&P 500, Costco has walloped the averages, returning 424% to investors.

Does that mean that Costco is the sure bet to outperform moving forward? Or does it mean that Target's stock is so depressed that it shouldn't be passed up? There's no way to tell with 100% certainty which interpretation is correct.

But below, I evaluate these stocks through three different lenses I use every time I start making an investment decision.

Financial fortitude

While money in the bank isn't very sexy to investors, it has a crucial purpose. When times get tough, economically speaking, cash gives companies options -- like buying back stock, outspending rivals, and even acquiring competitors. The opposite is true of debt, which can make an organization so fragile that it has to narrow its offerings in an effort to survive.

That's why financial fortitude is so important with an (always) unknowable future. Here's how these two stack up in terms of balance sheet strength:




Net Income

Free Cash Flow


$6.02 billion

$5.11 billion

$2.39 billion

$1.88 billion


$4.04 billion

$14.23 billion

$3.36 billion

$3.11 billion

Data source: Yahoo! Finance.

Given that Target has a market cap that is actually 40% smaller than Costco's, it's pretty impressive that Target has more net income and free cash flow than Costco. That's no small feat.

But when measuring financial fortitude, it's cash vs. debt that is the truly important metric. I include net income and free cash flow more as a way of ensuring that a company is bringing in enough money on an absolute basis to keep itself afloat.

While Target's debt load isn't crippling, it's certainly not as healthy as Costco's. If a recession were to hit tomorrow, Costco would be left with far more options for navigating the choppy waters than Target, and so the winner here is pretty easy to tell.

Winner = Costco.

Sustainable competitive advantages

Since I started investing eight years ago, no variable has been more predictive of a stock's success than the sustainable competitive advantages of the underlying business. Without such advantages, competitors will always be able to come in and offer the same products more cheaply.

Here again, I believe that Costco is the clear winner. Target's main advantages include its network of physical locations -- almost 1,800 worldwide -- and its brand, though the latter isn't much to speak of.

Costco, on the other hand, has a much stronger brand, as well as a business model that's tough to beat. Essentially, the company offers its products for such low prices, at such razor-thin margins, that it wouldn't be very profitable if sales were its only revenue stream. But yearly membership dues, at $55 per year, bring in the lion's share of profit.

With such a strong and growing membership base, and very little room for competitors to beat Costco's prices, this company is the clear winner in terms of its sustainable advantages.

Winner = Costco.


But then we come to this last metric and things get thorny. There are lots of ways to measure valuation; I've included four of my favorites below.
















P/E = price to earnings; P/FCF = price to free cash flow; P/S = price to sales; PEG = price/earnings to growth.
Data sources: Yahoo! Finance, SEC filings, E*Trade.

On just about every measure, Target is the cheaper stock. This is even after factoring in -- via the PEG ratio -- that Costco has better prospects for geographic growth moving forward.

Additionally, Target offers a better dividend yield than Costco -- 3.4% vs. 1.1% -- and Target's dividend is still very healthy, as the company used only 44% of its free cash flow to pay it out over the last year.

While Costco is clearly the superior company, its stock is very expensive relative to the prospects it has going forward.

Winner = Target.

To be honest, after this analysis, I don't think either of these companies are screaming deals. Costco is a better long-term deal. But I think it would be prudent for investors to wait until the stock is trading for a more reasonable multiple--ideally under 25 times earnings--which is what the S&P 500 trades for right now.