For most of this year, sentiment was mostly negative regarding major retailers Target (NYSE:TGT) and Wal-Mart Stores (NYSE:WMT). This was because these retailers' core customers are facing a difficult economic climate and have not seen their fortunes recover alongside the general economy. This resulted in poor earnings results from these two for several quarters.
Recently, however, this negative sentiment has improved significantly and their stock prices have been rising. Enthusiasm is building for Wal-Mart and Target because of their better-than-expected earnings reports and prospects for a good fourth quarter. Because of this, it might be an opportune time for income and growth investors to consider adding these two stocks to their portfolios.
Sentiment improves with earnings
The recent quarterly earnings reports out of Target and Wal-Mart soothed fears and both stocks rallied after releasing results. Expectations were very low for both companies, as they have each seen sales stagnate for many quarters. While their results weren't outstanding last quarter, there's hope that their businesses are close to rebounding from the malaise of the past year.
Target earned $0.54 per share last quarter, which was a drop of 2.9% year over year. That sounds bad, but Target shares rallied 7% after reporting earnings because expectations were far worse than what the company actually reported. Analysts expected Target to earn just $0.47 per share, which means Target beat earnings expectations by 14%. Importantly, this was the first quarter in the past year that Target reported an increase in U.S. comparable sales.
Wal-Mart earned $1.12 per share last quarter, which met analyst estimates. This was mostly due to surprisingly good performance in the U.S., where comparable-store sales increased 0.5% and reversed six consecutive quarters of falling or flat domestic comparable sales.
The biggest tailwind for the consumer right now is falling gas prices. As consumers are paying less at the pump than this time last year, the extra disposable income should be a boon for Target and Wal-Mart, especially in the critical holiday shopping season.
Strong performance looks set to continue
Crude oil has fallen dramatically in the span of just a few months. Lower prices at the pump help the average consumer. This is indicated in U.S. retail sales, which rose 0.3% in October. This topped expectations of 0.2%. Retail sales rose an even more impressive 0.5% last month after stripping out gasoline and other volatile spending items. Consumers now have more disposable income, and odds are good they will indeed dispose of it.
The timing for this could not be better. Consumers are expected to spend more this holiday season than last year, and if that happens, quarterly earnings reports will continue to improve. Estimates remain modest for the retail sector, but with an improving outlook for consumer spending, Target and Wal-Mart should be able to exceed analyst forecasts once again.
Wal-Mart has the added benefit of a successful small-store format working in its favor. Wal-Mart has steadily built its smaller stores to capitalize on new markets. For most of its existence, Wal-Mart had little to no presence in urban areas. It was essentially missing out on millions of new customers who lived in large cities. Recently, however, Wal-Mart has found success through its Neighborhood Market banner, which continues to outperform for the company. Wal-Mart's comparable U.S. sales grew 0.5% last quarter, but comparable sales for its Neighborhood Markets grew 5.5%.
For Target and Wal-Mart, future earnings growth should come in strong, which could send the stocks higher. Not only would shareholders benefit from these capital gains, but both Target and Wal-Mart reward shareholders with solid dividends. Target yields 3.1% and Wal-Mart yields 2.3%, which are icing on the cake in terms of total return potential. And both Target and Wal-Mart are solid dividend growth stocks. Wal-Mart has raised its dividend for 41 years in a row, and Target increased its dividend by 20% this year. That's why income and growth investors alike should consider buying Target and Wal-Mart.
Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.