This Is How Target Can Easily Generate 9%+ Total Returns At Today’s Prices by Eli Inkrot, Sure Dividend
The retail industry is notoriously finicky. What was popular last year likely won’t be trendy this year.
But all retailers are not created equally… Target has raised its dividend payments for 44 consecutive years (with a 45th on the way). The company’s strength makes it a safer investment than nearly any other retailer.
When it comes to finding future business champions, Warren Buffett and Charlie Munger have really excelled over the past seven decades. Q3 2021 hedge fund letters, conferences and more One could argue that these two individuals are some of the best growth investors of all time, thanks to their ability to spot companies like Coca-Cola Read More
This analysis shows why an investment in Target today has expected total returns greater than 9% per year. It also shows why Target is a top 25 high quality dividend stock using The 8 Rules of Dividend Investing.
The Retail Industry & Target
The retail industry may not be as bad as rapidly changing technological innovation, but there’s definitely a curve that retailers have to try to outpace. Which is why you’re seeing more and more “big box” stores put bananas next to t-shirts. The grocery business has lower margins (strong competition), but it’s a lot more predictable.
Whether it’s adding food to your stores, staying ahead of fashion trends, getting the advertising mix right or offering ever lower prices – retail has long been a tough business with a small margin for error. A lot of retailers have died off, while a few others have managed to adapt for quite some time now.
The company I’d like to talk about today is Target (TGT), which is now operating in its 54th year. There are two basic characteristics that stand out to me. First, you have the company’s cool, funky style. Target naturally competes on price with its much larger competitor Wal-Mart (WMT) – that’s just the nature of the business. What has been impressive, in my view, is that Target has offered similar (even better on occasion) prices while providing a cleaner and more enjoyable shopping experience.
And you don’t have to take my word for it, Target thinks so too:
Source: Target Corporate Fact Sheet
The second thing that sticks out has been the operating history. From 2006 through 2015 Target never earned less than $2 billion annually. Even during the throes of the Great Recession, Target was continuing to reward shareholders.
Target’s Amazing Dividend History
Target has now paid 195 consecutive dividends, having increased this cash component for 44 straight years. Think about that…
Had you owned shares at any point in the last four and a half decades, the very next year and any subsequent you would have received a raise. And investors could very well expect a 45th straight annual dividend increase shortly.
The image above shows Target’s dividend growth over the last ~30 years. You can see the sizeable dividend raises shareholders have received in recent years.
The company’s long dividend history makes Target 1 of just 50 Dividend Aristocrats. Here’s the full list of Dividend Aristocrats.
10 Year Performance Analysis
Let’s take a closer look at the company’s business and investment history to get a better feel for how the security has interacted with Target’s operating performance. Here’s a look at some important metrics moving from fiscal year 2006 through 2015:
On the top line Target turned in reasonable, but not exceptional results. Total sales went from about $59 billion to $74 billion over the nine-year stretch. If the profit margin remained the same during this period, you would see company-wide earnings growth that was in-line with total sales growth. However, this was not the case.
Target’s profit margin went from 4.7% to 4%, resulting in company-wide earnings growth of just 0.7% annually. What’s interesting is that this does not simultaneously imply that a shareholder’s earnings claim also grew this slowly. Instead, Target has a long-standing share buyback program that allowed 0.7% company-wide earnings growth turn into 4.3% earnings-per-share growth.
Target’s common shares outstanding went from 860 million to closer to 600 million at the end of last year. Expressed differently, for every 10 shareholders that existed in 2006, just 7 remain today – Target bought out 3 out of every 10 shareholders on your behalf.
The earnings multiple went from around 18 down to 15, resulting in slower share price growth. Finally, you have the dividend component, which grew at a very impressive rate of 20% per annum. This superb growth was possible for two reasons: underlying profit growth and an increase in the payout ratio.
Target could have elected to keep its payout ratio at 13% and grow the dividend by an average compound rate of 4.3% per year. Instead, the company elected to significantly increase its return to shareholders, resulting in a payout ratio that approached 50%.
Despite the robust dividend growth, the actual contribution of this cash payout to the bottom line was solid but not exceptional. This is because the starting dividend yield back in 2006 was just 0.7%. If you put the components together your come to a total annualized gain of about 4.3%. As a point of reference, that’s the sort of thing that would turn a $10,000 starting investment into $15,000 or so after nine years.
The above information is useful in two ways. First, it gives you a historical context of why a certain security may have performed as it did. Target’s shareholder return was aided by an exceptional share repurchase program and robust dividend growth rate, but hindered by a decline in the profit margin and earnings multiple.
Just as important is the idea that this sort of information can provide a framework for thinking about the future. You have a historical context to go along with the knowledge of how key components interact. Here’s a hypothetical set of assumptions to demonstrate what I mean, and give you a baseline view of what the security may look like today:
The middle column provides the same historical information as depicted above for reference. The right-hand column provides a set of hypothetical assumptions for the next decade. You’re not going to get this perfect. Instead, it’s about creating a baseline and thinking about the long-term prospects of the business and security.
On the top line 2% annual revenue growth is used – indicating total sales of about $90 billion 10 years from now. The future profit margin is presumed to be about 4.5%; higher than last year’s mark, but lower than what analysts are anticipating in the coming years. To be sure this sort of thing can be pressured by competition from Amazon (AMZN) and other formidable firms, but the idea is to come up with a starting point.
Over the past five years Target has spent an average of about $1.7 billion on share repurchases. Predicting the exact amount of future share repurchases isn’t feasible, but you know that the propensity is there. Previously Target was able to reduce the share count by nearly 4% annually. The above assumptions use a 2% annual reduction, as the payout ratio (and thus room for “organic” share repurchases) is now less than it had been.
By the way, these assumptions could very well be understated just as much as they could be overstated. Using 2% revenue growth, a 4.5% profit margin and 2% yearly share count reduction leads to 5.8% annual earnings-per-share growth. Analysts are expecting something closer to 9% over the intermediate-term.
Target’s average historical earnings multiple has been around 17 during the past decade. Using this P/E ratio results in share price appreciation of over 7% annually. Finally, you can add in the dividend component (now sitting above 3%). The presumed dividend growth rate isn’t spectacular, but it is still solid and in line with the company’s anticipated “glide path” for the security.
Putting these factors together, you come to a total expected return of about 9.4% per annum. As a point of reference, that’s the sort of thing that would turn a $10,000 starting investment into $25,000 or thereabouts after a decade.
By the way, this type of calculation also demonstrates the importance of the price you pay. Not too long ago shares of Target were trading around $82. Using the same assumptions as above with this price would result in the expectation of 7.5% annual returns – still solid, but well below what you might anticipate with the share price closer to $68.
That’s how I’d begin to think about an investment in Target. Operationally you might anticipate similar results to what the company previously displayed. Moreover, the effectiveness of share repurchases and the dividend growth rate could very well be less than what they once were. Yet these factors do not prevent Target from being a solid investment.
Indeed, the future results could very well be more impressive than the past…
This comes about as a result of the current price and valuation being offered. Instead of starting with an earnings multiple of around 18 and a dividend yield under 1%, you have a multiple closer to 15 and a dividend yield above 3%. This makes a big difference when you’re thinking about the suitability of an investment. It makes what I like to describe as the “investment bar” that much lower.
Target doesn’t have to grow exceptionally fast in order to justify reasonable or better returns.
The company ranks highly using The 8 Rules of Dividend Investing thanks to its:
- Above average 3.3% dividend yield
- Reasonable 50% payout ratio
- Below average price-to-earnings ratio of 15.4
- Solid total return prospects
Target is not the only retailer in the Sure Dividend database – which includes 180+ stocks with 25+ years of dividend payments without a reduction. There are a total of 16 stocks in the Services sector in the Sure Dividend database. Click here to download a free spreadsheet of these stocks, including 8 Rules Rank.