Target (TGT) is the 3rd largest discount retailer in the United States based on its $40 billion market cap. Only Costco (COST) and Wal-Mart (WMT) are larger. Target has increased its dividend payments for an amazing 45 consecutive years. The company’s long dividend streak shows that Target’s business is strong and stable enough to reward shareholders over a wide variety of economic conditions.
The company’s dividend streak puts it in rarefied air. Target is one of only 50 Dividend Aristocrats. Dividend Aristocrats are S&P 500 stocks with 25+ years of consecutive dividend increases. Target goes ex-dividend on Monday, November 14th. The company’s stock currently has a high 3.5% dividend yield and a low price-to-earnings ratio of 13.4. With that in mind is now the time to buy Target?
This article examines the investment prospects of Target.
Historical Growth & Future Growth Prospects
Target has managed to grow its dividend payments at a compound rate of 19% a year over the last decade. Earnings-per-share have grown at a more pedestrian 5.6% a year over the same period.
At this point it’s important to note that earnings-per-share growth (relative to dividend growth) is a better measure of underlying intrinsic value per share growth for Target. That’s because Target’s dividend growth is a function of significantly increasing its payout ratio.
A decade ago, Target’s payout ratio was around 15%. Today, the company’s payout ratio is 42%. It’s impossible for TGT to triple its payout ratio again over the next decade. Therefore, Target’s dividend growth is going to slow. I expect dividends to grow about in line with earnings-per-share going forward.
Target’s earnings-per-share growth of 5.6% a year over the last decade isn’t great. I’d put it in the ‘mediocre growth’ category. But here’s the thing… TGT grew despite massive managerial missteps.
Over the last decade, TGT dealt with a botched expansion into Canada, a highly publicized data breach, and the Great Recession. Despite all this, the company still managed to grow its earnings-per-share at 5.6% a year.
Even if Target grows at ‘just’ ~5.5% a year over the next decade, investors will see solid total returns when you factor in the company’s dividend yield. TGT’s 3.5% dividend yield combined with minimum 5.5% expected earnings-per-share growth gives investors expected total returns of 9.0% a year before valuation multiple changes…
There are two factors that – more than any other – determine the probability of success of an investment:
- Are you investing in a high quality business?
- Are you investing in a business that is either fairly valued or undervalued?
Looking at Target’s long-term dividend streak gives us a big hint as to whether Target is a quality business.
The company has a strong and durable competitive advantage that has allowed it to increase its dividend payments for 45 consecutive years.
Specifically, TGT benefits from its large size. In the discount retail industry, size matters. Large businesses benefit from economies of scale. They pass these discounts onto customers. Low prices attract more customers, making the company even larger, in a virtuous cycle.
On top of that, Target also has stores that are generally perceived as cleaner and a bit more ‘upscale’ than rival Wal-Mart. The company’s brand and reputation for fashionable merchandise enhance the company’s competitive advantage.
There’s little doubt Target is a high quality business with a shareholder friendly management… But is the company trading for fair value?
TGT currently has a price-to-earnings ratio of just 13.4. The company’s historical average price-to-earnings ratio over the last decade is around 15.5. Based on its own historical average price-to-earnings ratio, Target looks undervalued at current prices.
The company also looks (deeply) undervalued relative to the S&P 500. The S&P 500 is currently trading for a price-to-earnings ratio of 24.9. Now ask yourself, is Target significantly worse than the ‘average’ S&P 500 stock? I don’t think so… And yet, the company trades for a price-to-earnings ratio that is nearly half that of the S&P 500.
Final Thoughts On Target’s Investment Prospects
Target has a long history of rewarding shareholders with rising dividends. The company goes ex-dividend on November 14th – marking yet another dividend payment to shareholders. In addition to its high dividend yield, Target also regularly repurchases its shares. The company has reduced its share count by around 15% over the last 5 years.
Target’s management is objectively shareholder friendly judging by its dividends and share repurchases. The company has solid-if-not-spectacular expected growth as well. Even if Target manages to grow its earnings-per-share at just 5.5% a year, investors can still expect total returns of 9% a year at current prices, thanks to Target’s dividend yield.
But… Actual investment returns are likely to be higher. That’s because TGT appears undervalued at current prices with its low 13.4 price-to-earnings ratio. Target is ranked as a Top 100 stock on the Dividend Manager Website (#8 overall), and also ranks in the Top 25% of stocks using The 8 Rules of Dividend Investing. Dividend growth investors looking for exposure to the discount retail industry should consider adding Target to their portfolios.
Article by Ben Reynolds, The Dividend Manager