Target (TGT 0.18%) stock soared over 17% on Nov. 15 after its third-quarter 2023 earnings exceeded expectations. It's uncommon for a Dividend King stalwart like Target to pop that much in a single day. The results must have been unbelievable, right?
Actually, they were just OK, but it serves as a reminder that investing -- at least in the short-term -- is sometimes all about narratives. Let's unpack why the narrative has changed and where, more importantly, this major retailer could be headed over the long term.
Image source: Getty Images.
Target's changing narrative
There are a lot of places you could start when looking at the history of Target's narrative. But for me, the roller coaster began on Feb. 28, 2017, when Target stock fell over 12% to below $60 a share after the company announced a more than $7 billion investment in new and smaller stores, a higher digital footprint, e-commerce, exclusive brands, and more.
At the time, the narrative around Target was that it was a dying business model that was being heavily disrupted by Amazon. And in many ways, this was true. Target's cavernous stores with largely empty parking lots weren't a good look compared to a purely delivery-based model from Amazon.
But Target's investments paid off -- big time. Between Feb. 28, 2017, and Feb. 28, 2020, Target stock gained over 75%. It finished 2019 with then all-time high diluted earnings per share (EPS) of $6.36, an operating margin of 6%, and $78.1 billion in revenue. After losing value over the 10-year time period between Feb. 28, 2007, and Feb. 28, 2017, Target was finally posting some serious growth and proving that brick-and-mortar retail (when executed well) was still a strong business model.
Then, the pandemic happened. After initially falling with the broader market in March 2020, Target stock did the unthinkable. Between March 25, 2020, and the end of July 2021, Target stock nearly tripled, surging 187%. Profits soared as consumers turned to discretionary goods spending instead of travel and services.
Remember that impressive then record-high diluted EPS number of $6.36 in 2019? Well, Target more than doubled that in 2021 with $14.10 in diluted EPS. So in the span of less than five years, Target went from a company facing an existential crisis (whose restructuring plan was met with the utmost pessimism and doubt) to a Wall Street darling gushing gobs of profits that could seemingly do no wrong.
But Target had a weakness that was about to get exposed. Like other retailers, it faced long lead times during the worst of the pandemic, which pressured Target to order further ahead than normal and carry a large inventory. When inflation began increasing and interest rates continued to rise, Target was caught flat-footed with a massively overextended inventory. The solution was to slash prices to move goods off the shelves, which crushed Target's margins and profitability. So just like that, Target went from a historic rebound to an epic collapse.
Last week, Target's narrative changed yet again. On Nov. 14, Wall Street finally got the inflation report it had been waiting to see. And the next day, Target reported solid earnings and a 5.2% operating margin compared to 3.9% in Q3 2022. After reaching a three-year low in October, investors finally had a reason to be optimistic about Target again.
A lesson worth learning
The epic fall, rise, then fall again of what many would expect to be a steady and reliable dividend stock illustrates the power of narratives and market sentiment. And while you could argue Target's stock price simply reflected how the company was doing at any given time, there was no reason the stock should have soared so much in 2021 due to temporarily strong results, just as it should have never fallen so far this year due to, again, temporarily poor results.
As an individual investor, you don't have to agree with the market's assessment of a stock at a given time. One of the most powerful skills is discerning between what a company is really worth and how much of its current price is being dictated by a narrative that probably has nothing to do with the long-term investment thesis.
For a company like Target, what matters long-term isn't a surge in consumer spending due to the pandemic, a decline in consumer spending due to inflation, or even the market cycle. Rather, it's how Target engages with customers through its in-house brands and partnerships (like those with Starbucks and Ulta Beauty), the way it lays out its stores, where they are located and how big they are, how effective its Target Circle rewards program is, and if Target is keeping up with fashion and beauty trends, or design trends with its home goods.
These are the factors that can make or break a brand over time. Target turned its business around in 2017 not because of an economic cycle or an external factor, but by making it worthwhile to shop in-store for all of the reasons discussed and more. So instead of getting caught up in a particular narrative of the moment, a much better use of time and effort is to monitor how Target is doing on what matters to the long-term investment thesis.
Measurable strides
As mentioned, Target's recent quarter wasn't necessarily spectacular. Rather, it showed the beginning stages of a turnaround. After all, management's commentary was, in many ways, negative.
Target is keeping its inventory lean because consumer discretionary spending remains weak. Management pointed out that many staples categories are 25% to 30% higher than they were pre-pandemic, leaving less money in consumers' wallets for discretionary goods.
The narrative around consumer spending hasn't changed. But Target is finding success with what it can control, such as in-house brands, partnerships, increased engagement with Target Circle members, and more. In sum, its long-term investment thesis remains intact despite ongoing macroeconomic challenges.
Target has the makings of a lifelong holding
An investment thesis is a long-term case for owning stock in a company. However, the narrative surrounding a company is almost always based on short-term factors.
Getting too caught up in a narrative can lead to chasing an expensive stock higher or selling an inexpensive stock at a low price. Target stock is about the same price as it was pre-pandemic. But its profits are far higher, and it is on track to continue improving its margins and executing on what it can control.
Throw in a 3.4% dividend yield, and now looks like a great time to buy Target stock even after its epic run-up last week.
