Sometimes good stocks fall for the wrong reasons. Wall Street has a famously short attention span, and investors often shift their attention away from solid businesses just to chase the flavor of the month. These situations can set up excellent long-term returns for patient inventors who buy into a declining stock during a temporary period of low enthusiasm for its business.
You might be tempted to think that Target (TGT -0.51%) is in this situation right now. The successful retailer's shares haven't been shunned from the 2023 stock market rally, even as some of its peers have become more expensive. But there are some good reasons to leave Target stock on your watchlist for now. Let's take a look at the biggest.
1. Traffic is weak
Target executives in mid-May celebrated the fact that the company achieved modest sales growth in a tough economic environment. Revenue rose by less than 1%, mainly thanks to additional stores added to its base.
Target is facing the same challenge that peers like Costco are seeing, with demand dropping in the digital selling channel and for consumer discretionary products in general. Yet shoppers are avoiding Target to a greater extent these days. Customer traffic was up just 1% in the first quarter compared to Costco's 4% increase. Ulta Beauty, in contrast, enjoyed an 11% traffic boost.
It's hard to see a strong rebound scenario that doesn't involve better traffic figures. As a result, investors might want to simply watch for this metric to improve before buying Target's stock.
2. Margins are down
The company has made progress at raising prices and reducing inventory so that it doesn't have to offer aggressive promotions to keep products moving through the system. Profitability edged past management's goal in early 2023, in fact.
There should be more improvements ahead here as cost inflation slows and as Target's efficiency initiatives pay dividends. But the company is still only targeting an operating margin of closer to 6% of sales rather than the near double-digit rate it had achieved briefly during the pandemic.
TGT Operating Margin (TTM) data by YCharts.
The annual earnings outlook is much stronger at that 8% to 10% rate than at the 6% level that looks likely over the next year. Investors shouldn't get excited about the stock until the retailer can demonstrate a path back toward a higher operating margin.
3. The price is high
Target's stock price valuation has declined significantly since late 2022, when the company was enjoying phenomenal growth and expanding profitability. You can own shares for about 0.6 times annual sales today, or roughly half the peak valuation from 2022.
There are better deals in the industry right now. Walmart pays a strong dividend, is growing faster, and hasn't seen the type of huge margin slump that Target is enduring. For more growth-focused investors, consider Ulta Beauty, which is forecasting double-digit margins in 2023 as it wins market share in the makeup and beauty products niche.
Target's business will likely be back to setting sales and earnings records, and current shareholders don't need to abandon the stock. But there are more attractive options available right now in the retail industry.
