Why Target Is a Better Stock to Buy Now Than Wal-Mart

Source: Sven, via Wikimedia Commons. 

It's hard to find a retailer that has done more to shape today's retail landscape than Wal-Mart (WMT 1.32%). Founded in 1962, the company has gone from humble beginnings to being one of the largest employers in the world, with more than 11,000 locations across the globe.

Investors who bought Wal-Mart shares back in July 1971, following the company's IPO, would be sitting on returns of close to 400,000%! But investing in the stock market is much more about looking forward than it is looking back. And so, though Wal-Mart may still have good days ahead, as we usher in a new year I believe investors would be better off investing in one of the company's largest competitors: Target (TGT -0.70%).

Don't underestimate culture
For years, Wall Street has focused largely on short-term changes in a company's income statement when deciding if a stock is worth buying. While that's certainly one piece of the investing puzzle, such a myopic view ignores the fact that stocks represent stakes in changing and dynamic organizations.

To be honest, we can't complain too much about Wall Street's approach. Its loss is the individual investor's gain, as we have the time and patience to invest in what really matters in the long run. And if you're someone who's ever worked for... well, anyone... you know how important company culture is in creating greatness.

When it comes to which company has the better corporate culture, Target wins in a landslide, and there's plenty of proof in the pudding. One look at Glassdoor.com shows what employees think:

Source: Glassdoor.com. 

It would be easy to chalk these differences up to the fact that Wal-Mart is viewed by some as a leech upon society, paying workers such low wages that food drives need to be arranged to feed them. But that cannot account for the difference, as the average Target employee actually earns slightly less than his or her counterpart at Wal-Mart.

Know thyself
So what accounts for the difference? It could be that Target puts a major emphasis on positive culture at the workplace -- coming in first in CareerBliss' 2011 ratings for the company seeing the greatest jump in employee happiness on a year-over-year basis.

But it could also be due to the fact that Target has a very clear identity, while Wal-Mart's has been lost in translation recently. Fellow Fool Travis Hoium did a great job explaining the conundrum in a recent article.

In essence, Wal-Mart made its name by offering up the lowest-price goods possible, usually in rural areas. But with Amazon.com now taking away a sizable chunk of business, demographics shifting toward city living, and a focus that's not as appealing to higher-spending customers as it once was, Wal-Mart is in something of an identity crisis.

The same is not true of Target, which has always focused on suburban and urban customers, and has a product mix that's decidedly aimed at middle- to upper-middle-class customers. One look at recent sales trends shows what I'm talking about:

Source: Fool.com, SEC filings. 

If we peer at each company's valuation, Target still seems like the more compelling buy. Though Target currently trades for about 17 times earnings, and Wal-Mart for a more-favorable 15, if we look at price-to-free cash flow, or FCF, Target trades again at 17 times, but Wal-Mart rises to 22 times. This makes Target appear to be a much better deal, especially for a faster-growing company.

In addition, Target not only offers up a better dividend yield, but it also has used up far less free cash flow to pay out dividends over the last 12 months. With just 33% of free cash flow being used for the payouts, Target has the ability to weather a financial crunch and/or easily increase dividends over time.

When you combine the trends -- culture, sales, and valuation -- it seems to me that Target is clearly ripe for the picking for investors heading into 2014, which is why I'm making an outperform CAPScall for the company on my All-Star CAPS profile.