They operate in the same industry, but Costco Wholesale (COST 1.01%) and Target (TGT 0.18%) are vastly different investment choices. Wall Street favors the warehouse retailer right now thanks to a few impressive competitive and financial assets, including its stable growth outlook amid shifting consumer shopping trends.
Yet, Target is on track to boost profit margins beyond Costco's in 2023. It also pays a bigger dividend and is valued at a discount than its larger peer. So let's compare the two retailers to see which one is the better option for your portfolio right now.
Growth goes to Costco
Costco comes out well ahead when it comes to its growth trends. That's obvious from comparing the two companies' same-store-sales trends, which were up 4% for Costco last quarter and down 5% in Target's case. The warehouse giant's lead with shoppers is even more obvious when you look at metrics such as customer traffic and renewal rates .
Costco is boosting traffic in 2023 thanks to high demand for consumer essential products. Target, meanwhile, is seeing slumping traffic as shoppers move away from spending in areas such as home furnishings. This fact alone helps explain why Costco's stock is up 21% this year while Target's has declined by nearly 30%. Investors prize its ability to grow the business through a wide range of selling environments.
Margins are on Target
Target briefly reached an 8% operating profit margin during the high-growth phases of the pandemic. Its profitability then slumped through 2022 and early 2023 as shoppers dramatically reduced their spending in areas that had previously been soaring.
The good news is that Target is now on track to return to its pre-pandemic profit margin of 6% of sales. That amounts to nearly double Costco's rate, and there's room for further gains ahead once the industry enters its next cyclical upturn. That's because Target has done the hard work of reducing inventory levels over the past several quarters to better match up with demand. It's investing heavily into popular quick delivery services, too.
COST Operating Margin (TTM) data by YCharts
Costco, meanwhile, keeps profit margins low so it can maintain its pricing advantage. That's the right strategy for long-term growth, but it does mean somewhat lackluster earnings in a given year.
Dividends and value
Target will also appeal more to income investors today. The stock pays a meaty 4% yield compared with Costco's sub-1% rate. That dividend has been rising steadily for decades, making Target one of the few retailers on the exclusive list of Dividend Kings. Costco tends to rely on large but sporadic, one-time dividend payments. Those are exciting when they land in an investor's portfolio, but their surprise nature makes them hard to rely on for income.
Ultimately, your choice between these two stocks will depend on your appetite for risk. Costco is valued at roughly equal to annual sales, while Target can be purchased for about 0.5 times sales. That gap makes sense given that Costco is growing and has a steadier earnings outlook. And choosing Target today requires you to take on more short-term risk that sales trends will remain negative in exchange for the potential of rapidly expanding earnings in coming years.
Costco seems worth the premium as it delivers the type of stability that's rare to find in the retailing world. Investors are right to prioritize that steadiness even though they can find more income and higher profit margins elsewhere in the industry.
