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.
Valuation
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.
Nasdaq.com 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
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.
