Friday, December 1, 2017

Costco or Target - you decide

What an interesting decision. A lot of bloggers have recently weighed in on this conundrum.  I applied my Dividend Machine fundamentals to help decide which is the better stock for me.    But frankly that analysis made the decision no easier.  I will post the Dividend Machine data comparison at the end of this post.    

Business Model Differentiation

These two retailers differentiate their business by their business model.  Target is dependent on profit margins which are 3.8% right now.  Costco also has positive profit margins at 2.08% but Costco uses membership fees to fill their coffers. In 2016 COST pulled in $2.6 billion in membership fees.  These fees help to smooth out their revenue stream.  

Target, on the other hand, is totally dependent on making money through margins.  Target must make money on their merchandise and they are pretty good at it.  However, their sales are not growing.

For me, the real question is a trade off surrounding yield, revenue trends and value.

Dividend Yield

Dividend Yield would seem to be straight forward.  On first inspection, Target (TGT) wins with a yield of 4.38% versus Costco’s (COST) 1.09%.   However, over the past five years Costco has delivered three special dividends that are substantial.   

Will COST be able to continue this trend of special dividends?   If they do continue to accumulate cash and share it with investors through special dividends, their meager regular dividend yield looks more tolerable.

Take a look at Costco's and Target's quarterly cash & equivalents for the past 5 quarters.


Both stocks have increasing amounts of cash on their balance sheet. If you are paying for cash, you can see why COST is so much more expensive than TGT.

Revenue trends

Over the past few years, I have been using revenue trends prominently when working my income portfolio.   Sales drive revenues which drive the cash flow needed to pay dividends.   

A lot can happen on the way from revenue collection to dividend payout but without revenue, nothing will flow to the investor.  The table below presents a comparison of TGT and COST revenues.  



Clearly COST is the winner on this metric.  If this kind of revenue growth continues, future special dividends just maybe in the works.   TGT, on the other hand has stagnant revenues more like Walmart (WMT.)   However, you pay dearly for that revenue growth and that is where valuation comes into play.


Costco is expensive.  COST is up today based on recent earnings and a euphoric market.  COST sports a P/E ratio (price to earnings ratio) of 30.   Whereas, Target is considered cheap.  Target (TGT) interestingly is down today.  Current P/E ratio is 13.  This is quite a difference.   If COST has a bad quarter, the stock could take quite a hit.   However, without revenue growth, we are not going to see TGT stock price increase without some other catalyst.

The table below shows a few additional measures to take into consideration when looking at value. 

The metrics that stand out are Book Value and Peg Ratio.   Investopedia is the source of this definition of Book Value:  " It serves as the total value of the company's assets that shareholders would theoretically receive if a company were liquidated."

Target's book value as related to the cost of each share of stock ($60.91) is better than Costco's book value based on a share price of $183.45. is the source of this definition of PEG ratio:  "The PEG ratio is the Price Earnings ratio divided by the growth rate. The forecasted growth rate (based on the consensus of professional analysts) and the forecasted earnings over the next 12 months are used to calculate the PEG." Learn More

A low PEG ratio may indicate a stock is undervalued and higher PEG ratio can suggest over value.  To me, I am still confused as to which stock is better.

Debt to Equity Ratio

Readers of my blog know I place a lot of emphasis on balance sheet and I find D/E ratio one of the easier measures for ordinary investors to find and to understand.   Neither stock’s D/E is onerous like Home Depot’s D/E ratio of 12, but one is better than the other.

Industry average D/E ratio is .54.  Costco carries a D/E ratio of .61.  Target’s D/E ratio is 1.01.  Both stocks have the cash flow necessary to meet their obligations with neither company in danger of going belly up due to too much debt.

Dividend Machine Fundamentals Table

My Take

So here we are having to decide to buy an expensive low yield stock with the potential to deliver a big income payday or to buy a high yielding, cheap, slow growth stock (value trap.)    I am going to buy both, but I may wait for COST to correct after today’s significant rally.  Target has calls that will return 11% if called away so I will wade in with that strategy. 

Only you can decide what works for you.  I am an income investor and I like to be paid to wait.  I also like to juice my income with covered calls.  Oddly, the usual technique of selling calls to boost income is available on the faster growing, lower yielding stock.  That is not the case with COST versus TGT.  But again, nothing about this seems to be normal.

M* MoneyMadam

Disclosure:  Long TGT with calls:  expect to buy COST 

Posting note:  Bought TGT at $59.50 and sold January $62.50 call for $1.50.