Target (TGT 1.28%) and Costco (COST -0.55%) stocks valuation has diverged in the past year or so. While Wall Street was equally optimistic about both retailers during most of 2021, investors aren't as excited about Target today as they are about the warehouse giant's business.
Both companies recently issued updates describing their latest growth and earnings trends. So, let's see which stock looks more attractive in the context of that early 2023 momentum.
The growth matchup
Costco is winning in the growth arena, mainly because its value proposition is the clearest during inflationary times like these. Comparable-store sales were up 7% in January, while Target just reported a 0.7% increase in the quarter that ended in late January .
Costco's customer traffic was up 2.2% in the core U.S. market, while Target's increase was a more modest 0.7%. Shoppers are increasingly choosing the warehouse giant because of Costco's price leadership across key categories like groceries and home maintenance supplies. Investors have good reasons to expect this performance gap to continue through 2023, especially if economic growth rates continue slowing and inflation stays elevated.
Profit margins
Target's profit margin has crashed over the past year, falling from 8.4% to 3.5% in fiscal 2022. That slump is the main factor behind the stock's decline in recent months. In earlier phases of the pandemic, investors had high hopes that Target could achieve profits in the high single-digit rate. Now, it appears it might be at least another year before the retailer can return to its pre-pandemic profitability of about 6% of sales.
COST Operating Margin (TTM) data by YCharts
It is true that Costco's margin is still lower, but the warehouse giant still comes out ahead on earnings power. Most of its profits come from membership fees, after all, and the outlook for that revenue stream is bright. Costco's renewal rate ticked up last quarter beyond 92%, indicating record-high customer loyalty. The company is due to raise annual fees soon, which deliver an immediate boost to the business.
Target, meanwhile, is much more exposed to shifts in consumer-spending preferences. As a result, shareholders can expect more volatility in annual earnings and likely weaker profits at least through 2023.
The price is right
Costco's stronger business is no secret on Wall Street. The stock is outperforming the market this year thanks to optimism around its sales and earnings outlook through what could be a tough operating environment in 2023. That fact might set shareholders up for some better returns with Target stock. It is priced at just 0.7 times annual sales compared to 0.9 for Costco.
The main difference is that with Target the bullish thesis relies on an operating turnaround that hasn't started yet. The company is aiming for faster growth and steady improvement in its margins through 2024, and management has made progress positioning for that rebound by cutting inventory and continuing to invest in its online platform.
Still, with Costco you get a high-performing business that simply needs to maintain the market-beating momentum that shareholders have seen for years. That's why most investors would prefer the warehouse giant over Target right now, at least until there's more clarity around Target's ability to climb out of its current funk.
