On Sept. 10, Target (TGT 0.18%) shareholders as of the close of business Aug. 16 will receive a $1.10-per-share quarterly dividend. Target has paid and raised its dividend for 52 consecutive years, making it a member of the celebrated list of Dividend Kings.
The raise gives Target a forward dividend yield of 3.4%, which is meaningful because it is close to the 10-year risk-free rate of 4.3%. Investors in Target stock get a sizable passive income stream while also being invested in the growth of one of America's largest brick-and-mortar retailers. However, investing in Target stock is also a risk: It can go down in value, which is exactly what has happened in recent years. Target is currently hovering around a three-year low.
Let's take a look at Target's business and valuation to see if the stock is worth owning or if the risks outweigh the potential reward.
Target is incredibly profitable
Target has received a lot of (much-deserved) criticism for misreading consumer behavior trends, carrying too much inventory, and implementing steep price cuts to reduce inventory. But through it all, one point that may be getting lost is Target's profitability.
Even when Target slashes prices and consumers are spending less on discretionary goods, the business is efficient enough to still turn a very sizable profit. In its recent earnings release, Target cut its full-year earnings-per-share (EPS) forecast from a prior range of $7.75 to $8.75 to a new range of $7 to $8. The guide down illustrates the challenges that retailers are facing, which are not unique to Target.
With its stock price around $131 per share, Target would have a price-to-earnings (P/E) ratio of 18.7 at the low end of its guidance and 16.4 at the high end of its guidance, which is below the S&P 500 average P/E ratio of 23.5. So even during a period where Target's earnings are seen as weak, the company is still making a lot of money and the stock's valuation has gotten more attractive as the price has come down.
Target stock is undervalued
Target's median P/E ratio over the last 10 years is 16.8. So the stock historically trades at a discount to the market. Now, the question for long-term investors is whether Target deserves a higher multiple. Put another way, is Target going to accelerate and sustain a higher growth rate to excite investors? Or is it going to grow at the same steady pace (in which case the stock is more or less fairly valued)?
Answering this question requires looking at Target's market position and the business itself. Target is only located in the U.S.. It is therefore extremely reliant on the U.S. consumer, which has been cost-conscious amid high inflation and a slowing economy. But, if you believe in the long-term strength of U.S. consumer spending, then a retailer like Target that is all in on the U.S. and has a powerful brand is a compelling offering.
The second part of the question is asking what Target has done and is doing to improve its business and tap into growth. If there's one key point about Target that has been lost amid the slowdown in its performance, it's the execution of Target's long-term plan to get more out of each store and improve the customer experience.
Target has done a masterful job differentiating among its three types of stores: SuperTarget, Target, and small-format Target. The company has grown its rewards program, Target Circle, to over 100 million members. It has also partnered with Starbucks to add beverage delivery with curbside pickup and returns. And Target's partnership with Ulta Beauty has been a bright spot despite a disappointing consumer appetite for discretionary products.
Zoom out and it's clear that Target is listening to customers and is putting the right pieces in play to differentiate from its competitors.
Target is a dividend stock worth buying and holding
Income-orientated investors want to know if a company can grow earnings to support future dividend raises. Target is showing that it can still generate sizable earnings during a tough period, and it has the strategy in place to sustain growth over the long term.
With a payout ratio of just 59%, Target's dividend is manageable and leaves plenty of room for the company to repurchase stock or reinvest in the business.
The investment thesis is well intact. Now is the time to take a look at Target stock as an excellent option for investors who value brand power and a sizable yield.
