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Better Buy: Costco Wholesale Corporation vs. Target

By Demitri Kalogeropoulos - Oct 9, 2017 at 6:58PM

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Two of the country's biggest retailers are stacked against each other as investment candidates.

Costco (COST 1.35%) and Target (TGT 0.81%) are among the nation's biggest retailers. And given the customer traffic slowdown that's pinching the industry today, both companies have been posting unusually weak operating results lately. 

The good news for investors is that the business slump pushed shares lower this year even as the broader market has rallied. That underperformance might set the stage for higher long-term returns -- but which retailer looks like the stronger bet today?

One hand showing a thumbs-up and another showing a thumbs-down sign.

Image source: Getty Images.

Metric

Costco

Target

Market capitalization

$68 billion

$31 billion

Sales growth

3.8%

(0.5%)

Dividend yield

1.3%

4.35%

Profit margin

2.1%

3.9%

Price-to-earnings ratio

25

12

Price-to-sales ratio

0.53

0.46

Year-to-date performance

(3%)

(21%)

Sales, profit margin, and sales growth are for the last full fiscal year. P/E and P/S ratio cover the trailing 12 months. Data sources: YCharts! and company financial filings.

Buy Costco stock for predictable growth

If you prefer stronger operating trends, Costco is easily your choice. Sure, sales growth recently slowed for the second consecutive year, dipping to a 3.8% result from 4%. Yet the warehouse giant remains one of the fastest-growing retailers around. Its comparable-store sales results and customer traffic metrics are holding up in consistently positive territory while Target last posted a 1% traffic decrease and a slight comps decline.

Costco's profit outlook is brighter, too. Most of its earnings come from membership fees rather than product markups. Thus, its net income isn't exposed to the dips that other national retailers, including Target and Kroger, are enduring as they cut prices to defend market share. Costco's prices are already near breakeven, and so there isn't as much risk of gross profit margin sinking further.

TGT Gross Profit Margin (TTM) Chart

TGT Gross Profit Margin (TTM). Data by YCharts.

If anything, profits appear set to continue to march higher as the retailer's membership fee increase -- its first in almost six years -- rolls out to its subscriber base over the coming months. Target's earnings are headed in the other direction due to scaled-up investments in its stores and holiday-season promotions.

Buy Target stock for income and value

On the other hand, Target is a more appealing stock if you're looking to profit from the deep pessimism that's currently gripping retailing investors. Its shares have fallen much harder this year while Costco's have mostly held flat. 

As a result, investors are now paying just 11 times trailing earnings for Target stock, a huge discount from Costco's and the broader market's P/E of 25. Yes, its weaker operating trends mean the business could take a bigger hit during the critical holiday shopping season ahead. On the other hand, it wouldn't require much of a customer traffic bounce to push Target ahead of the low expectations that Wall Street has assigned to the business.

Target is also the more attractive income investment, in my view, considering that the company hasn't missed an annual dividend boost since 1967. That streak makes it one of just a handful of retailers that can claim status in the exclusive club of Dividend Aristocrats. Its more than 4% yield is also twice that of the broader market and trounces Costco's meager 1%.

Still, my partiality for robust sales growth leads me to prefer a Costco investment right now. It's true that the warehouse titan's stock isn't likely to soar anytime soon since it's already priced at a premium. But Costco's membership-based business is a retailing fortress that should keep generating steadier, and more consistently positive, returns for investors.

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Stocks Mentioned

Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
COST
$485.76 (1.35%) $6.48
Target Corporation Stock Quote
Target Corporation
TGT
$142.38 (0.81%) $1.15

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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