Target (NYSE:TGT) and Costco (NASDAQ:COST) are rivals in the retail space. However, as omnichannel shopping trends evolve, so do competitive advantages and retail performance. 

Both retailers are leveraging in-store pickup and e-commerce sales, but both retailers are also building a bigger footprint in new markets. For example, Target is opening new smaller stores in urban areas and college towns, and Costco is making in-roads into China along with its domestic expansion efforts.

So, as these two retail giants evolve to meet the ever-changing needs of the sector, which stock is a better buy?

A woman with a grocery cart

Image source: Getty Images.

The case for Costco

Following a sharp downturn in December 2018, Costco has been on a tear in 2019, and its stock is up about 40% on the year. Costco has shown steady growth for several years now, with earnings per share (EPS) up 8% to $5.77 in fiscal 2017 and 18% to $6.83 in fiscal 2018. 

That good news can, in part, be attributed to Costco's competitive advantage, which is its membership program. Costco members pay yearly fees so that they can buy bulk goods at discount prices. The additional income those fees provide Costco allows the retailer to hold its own against high-level competitors like Amazon and Walmart. Costco re-signed more than 90% of its memberships and had 95 million members worldwide in 2018, compared to 85 million in 2016.

In addition to a steady income, Costco's membership fees encourage consumer loyalty. By paying for a membership, Costco becomes somewhat of a private club. Shoppers are motivated to take advantage of the "club" because they have already paid for its benefits. 

Costco is leveraging this "motivation" to help it find new revenue streams. Online, Costco's loyal customer base helped expand its e-commerce efforts (e-commerce earnings were up 32% in Q2 of 2019). The desire to join is helping its expansion efforts into China. Its first China store opening in Shanghai in August of 2019 created quite a stir, netting 139,000 new memberships in one day. According to published reports, shoppers lined up for hours and "wrestled over detergent and grabbed at meat with their bare hands while the butcher was still trying to cut it." Costco was forced to temporarily close the store and send an alert to members urging them not to come until things settled down.

Moody's Vice President Charlie O'Shea, opined that Costco will have to tailor its offerings for the Chinese market to keep up this level of interest, but Costco has succeeded in other international expansions. In addition to its 543 locations in the U.S. and Puerto Rico, Costco has 100 stores in Canada and opened stores in 10 other countries. 

Costco is oozing confidence, which investors love. The company authorized a $4 billion stock buyback program that will expire in April 2023. The plan replaces a recently expired $4 billion plan that had $2.2 billion worth of authorization remaining. 

Still, there are tangible risks for Costco. Costco raised its minimum wage to $15-an-hour (from $14-an-hour) in March 2019 in response to a tightening labor market, as did Target and Amazon. However, Costco went a step further and announced a pay raise for supervisors and paid parental leave for its hourly workers. The added expense could narrow margins and require Costco to raise prices to cover the costs. On the other hand, higher wages could boost worker loyalty and productivity, which can offset some of the added expense.

The case for Target

Target's second-quarter 2019 earnings report in August beat pretty much all Wall Street consensus estimates. Comparable sales have grown by 10% over the last two years, which is Target's best performance in a decade. 

As more retailers work to take advantage of trends in omnichannel delivery of services for customers, both Target and Costco are offering things like in-store pickup and working to make shopping more convenient, but Target's initiatives on this score are intense. They include a focus on its private-label brands, Drive Up services, one-day delivery via Shipt, supply chain upgrades, the Circle loyalty program, Target+ marketplace, and expanded self-checkout options, all of which have brought new customers. Target+ adds third-party merchandise to Target.com, but Target restricts the third parties allowed on the e-commerce platform. Drive Up allows consumers to shop using the Target app, select Drive Up at checkout, and to have vehicles loaded once goods are ready. 

Target has also been investing in store remodeling and store relocations. And it continues to open smaller brick-and-mortar stores in high-foot-traffic areas where the retailer is offering more curated merchandise specific to that location.  

What's the better buy right now?

Both of these companies are performing well in what is an overall unsteady retail environment. Costco serves the loyal bulk discount shopper, while Target is attracting the urban shopper who is less worried about volume and discounts and more concerned with convenience. In terms of resilience, Target's diversification strategy of building smaller outlets in high-density areas is paying dividends.  

That said, Costco's loyal customer base is solid, and its membership program is expanding. I see more room for growth with the company than with Target. And while Target's focus on convenience and localization is responding to consumer demand, other brick-and-mortar and e-commerce players are doing much the same thing.

Costco is likely the better investing bet if only because, while Target is trying to lure customers through its doors, Costco is so popular it's having to warn people away (at least in Shanghai).