Is Target a Good Stock to Buy?

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Many discount retailers got off to a slow start at the beginning of this fiscal year, and Target (NYSE: TGT), whose fiscal Q1 ended in early May, was no exception. According to the company’s 10-Q, revenue was about flat for the quarter versus a year earlier, with an increase in store count being offset by a small decrease in same-store sales.

Thanks to higher interest expenses, Target recorded a 29% decline in earnings compared to a year ago, and if we ignore the proceeds on sale of its credit card accounts receivable, cash flow from operations was lower as well.

Target currently trades at 17 times its trailing earnings, a valuation which seems to indicate that the market is expecting the retailer’s prospects to improve going forward. Wall Street analysts predict that this fiscal year’s earnings per share will be about even with last year’s before the company significantly grows its EPS in the fiscal year ending in January 2015; as a result, the forward P/E is 13.

That would place Target close to value territory, though of course we wouldn’t have too much confidence in the business suddenly picking up next year. As might be expected from a discount retailer, Target’s stock price has a fairly low correlation with market indices at a beta of 0.5. The company recently increased its quarterly dividend payment, but the yield remains unremarkable at 2.4%.

We track quarterly 13F filings from hundreds of hedge funds and other notable investors as part of our work developing investment strategies; we have found, for example, that the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year (learn more about our small cap strategy).

The largest Target shareholder at the end of March out of the filers we track in our database was John Levin’s Levin Capital Strategies, which reported a position of 1.9 million shares (find Levin's favorite stocks). Billionaire Ken Griffin’s Citadel Investment Group was a buyer of the stock in the first quarter of 2013 (see Griffin's stock picks).

Target’s peers include larger competitor Wal-Mart (NYSE: WMT) and Costco.

In terms of trailing earnings, Wal-Mart is priced at a slight discount to Target, at 15 times trailing earnings, though its growth going forward is supposed to be lower and as a result, the two retailers are valued about even with each other as far as forward P/Es go. Its most recent quarterly report actually showed decent revenue and earnings numbers, and with similar defensive characteristics, it might be a better prospect.

Costco has been growing nicely, with revenue up and net margins expanding, but markets have seized onto that already. With trailing and forward earnings multiples of 25 and 22, respectively, the stock is priced at a bit too much of a premium for us right now.

We can also compare Target to dollar stores such as Dollar General (NYSE: DG) and Dollar Tree (NASDAQ: DLTR). Each of these companies experienced revenue growth in the high single digits in their most recent quarter compared to the same period in the previous fiscal year.

Dollar Tree did a better job of cutting its costs, resulting in a 15% increase in earnings over the same time frame, but Dollar General managed at least modest growth on its bottom line as well. These two stocks also tend to be even less connected to the overall economy than Target or Wal-Mart, with betas of about 0.1 in each case.

However, Dollar General and Dollar Tree each feature a trailing earnings multiple of 19 and therefore, are priced at a premium to Target and Wal-Mart on that basis. Still, given their superior financial performance, it’s possible that they will continue to grow enough to justify this higher pricing.

As a result, we don’t like Target very much right now. Wal-Mart appears cheaper on an earnings basis, with its recent numbers looking better than Target’s if anything. In addition, while the dollar stores we’ve mentioned here are certainly not cheap enough to be pure value stocks, they have continued to grow their earnings and could be worth investigating as well.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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