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Should You Buy Target Stock for the 4% Dividend Yield?

By Nicholas Rossolillo - Updated Dec 27, 2017 at 3:01PM

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The retailer’s stock has fallen on hard times, but a best-in-class payout makes that forgivable.

2017 hasn't been the best of years for big-box store Target (TGT 0.81%). The company launched an ambitious makeover strategy to update its selling model for the digital age and is dipping into its profit margins to do it. Target has a long history of paying and raising its dividend -- it's even a Dividend Aristocrat -- but given changes in the retail world, there is reason to double-check this one.

The bad

After a recent rebound in share prices, Target's dividend has an annualized yield of 3.8% as of this writing. However, the stock is down 9% for 2017 as of this writing and a falling stock price leads to a higher yield.

Foot traffic has been a struggle in recent years as consumers steadily trend toward online shopping. To fight back, management announced a multiyear effort that involved new store formats and remodels, new exclusive brands, new order fulfillment options, and price reductions.

A business willing to invest in itself is a good thing, except this investment was more about staving off competition like Amazon (AMZN 3.15%) more than it was about investing for growth. Sales have been stagnant the last few years, and that rebound effort is going to cost money. Through 2019, management said it will spend $7 billion to update the business model. Annual operating profits have been running about $4.5 billion a year.

TGT Revenue (TTM) Chart

Data by YCharts.

Adding to the pressure on profit margins are other spending items, like Target's recently announced acquisition of same-day delivery company Shipt for $550 million. With so much going out to get Target ready for the 21st century, if business doesn't pick up at some point, that could eventually put the dividend at risk.

Three women with shopping bags walking down a street.

Image source: Getty Images.

The good

The last two years will certainly go down as transition years for Target, but business isn't as bad as one might think. Foot traffic in-store has stabilized as of late, and the company continues to grow its online sales north of 20% every quarter.

Full-year 2017 profits are expected to be down as much as 12% from 2016, but that's much better than the initial forecast management provided. Free cash flow -- money left over after basic operations are paid for -- is still down this year, but still high enough to easily cover Target's current $0.62-a-share quarterly dividend. The company's payout ratio is around 50%.

TGT Free Cash Flow Per Share (TTM) Chart

TGT Free Cash Flow Per Share (TTM) data by YCharts

As for spending on acquisitions like Shipt, Target has plenty of cash. As of the last reported quarter, the company reported over $2.7 billion in cash and cash equivalents and over $40 billion in total assets. The company can afford the occasional spending spree.

Perhaps the most telling sign that Target's dividend is safe, though, is that it's still on the rise. Over the summer, the company increased its quarterly payout to $0.62 a share from $0.60 a share. That's only a 3% raise for shareholders, but companies in dire financial situations don't increase dividends.

The last payment, in December, was the company's 201st consecutive quarterly dividend since it began paying one in 1967. While times may be difficult right now, this isn't the first time Target has maintained its payday in the face of economic challenges.

TGT Dividend Chart

TGT Dividend data by YCharts

The long and the short

The good news for the big-box store is beginning to outweigh the bad. Just when you thought Target might be sunk by online competitors, the company is showing renewed signs of life by benefiting from the same online shopping trends that originally put its future in question. Plus, the fact the company pays a dividend at all is impressive. Amazon doesn't pay one, and retail king Walmart's current dividend yield is only at 2.1%.

Though some headwinds will persist, Target's dividend looks like it will continue to be a good investment for investors looking for income.

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Stocks Mentioned

Target Corporation Stock Quote
Target Corporation
TGT
$142.38 (0.81%) $1.15
Wal-Mart Stores, Inc. Stock Quote
Wal-Mart Stores, Inc.
WMT
$122.63 (0.86%) $1.05
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$109.56 (3.15%) $3.35

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

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