Retail giant Target (TGT -0.59%) has been on such a huge growth spree over the past few years that it's easy to forget it pays a dividend. Not only that, but last summer it joined the exclusive list of Dividend Kings, or companies that have raised their dividends for at least 50 years. Does that make Target a great dividend stock? Let's take a look.
What makes a great dividend stock?
Dividend investors are interested in earning income on their investments. It's one investing style out of many, such as growth investing or value investing. Most investors' interests are best served when they have a diversified portfolio with a well-rounded group of different kinds of stocks, but retirees in particular typically focus on income since they're not bringing home a paycheck.
Image source: Target.
A great dividend stock should have three features: a high yield, a growing dividend, and a stable source of cash to fund the dividend.
Now, a high yield can be relative. There are a few super-high yields, often issued by REITs, or real estate investment trusts. REITs are structured so that they have to pay out 90% of their income as dividends, so they are naturally excellent dividend stocks. Some examples of very high-yielding REITs are Annaly Capital Management, which currently yields 12.48%, and Sabra Health Care, which yields 8.46% at the current price.
As impressive as these sound, investors -- even those focused on income -- wouldn't want only these kinds of investments. These may have more exposure to macroeconomic factors (such as rising interest rates and shifting retail trends) than many stocks, which could impact their operations and ability to pay out.
A growing dividend is important for a few reasons. For one thing, it means the company is operating well and bringing in greater amounts of cash to support its dividend. In addition, the dividend should grow at a rate that is fast enough to make it a worthwhile investment when there are other instruments to consider, such as bonds.
Finally, it only makes sense to invest in a company that has a stable income source with which to fund its dividend. This is often tied to its payout ratio, or the amount of its cash that it pays out as dividends. If it's paying out too much, the worry is that it won't be able to fund operations. But if it's too low, it may not be paying out a lot of its cash to shareholders.
Does Target fit the bill?
Target made waves throughout the pandemic with its superior omnichannel services that powered high sales growth. Revenue increased more than 20% year over year in 2020, with drive-up sales alone growing 600%. But prior to about 2017, growth was faltering, and Target was just another big retailer trying to make it work.
So far, in the aftermath of the early pandemic shopping binges, its digital investments are fueling more robust growth. In 2021, sales grew 13% on top of the 2020 number, and net income grew 12%. Between omnichannel investments, its own brands, and innovative shipping strategies that use stores instead of distribution centers, the retailer's long-term potential looks solid.
Chief Financial Officer Michael Fiddelke reiterated Target's priorities: investing in the business, paying the dividend, and share repurchases. Target raised its dividend 32% in June to $0.90 a share quarterly, which was its 50th consecutive raise. At the current stock price, Target's dividend yields 1.61%, which is above the S&P 500 average of 1.44%.
Meanwhile, Target's current payout ratio is just 22.3%. That's low, because the company's first priority is investing in its business and ensuring it can pay the dividend for years to come.
If you're only looking at the yield, Target is just above average. But if you're looking for a dividend stock that offers the full trifecta of high yield, growth, and cash generation, Target is an excellent choice to provide a long-term source of income as a great dividend stock.
