Beat the market and sleep well with this stock
Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Famed economist Paul Samuelson once said "Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas."
That's not to say investing can't be exciting; it's an amazing feeling to watch the positive effects on your portfolio after an investment thesis comes to fruition. Mr. Samuelson, however, had a point: If you think investing is like gambling, you're doing it wrong.
Whether you are emotionally capable of weathering the ups and downs of the most volatile stocks, or would rather watch your savings account slowly appreciate, your investments should allow you to sleep peacefully.
But what if I were to tell you about a responsible, predictable company which has paid a dividend every year since 1967, raising it 41 times in those 45 years? In addition to its rising dividend, this company has seen its shares appreciate nearly ten-fold over the last twenty years, is still conservatively valued, and has plenty of room to grow.
Sleep-deprived investors, meet Target Corporation (NYSE: TGT).
For the sake of comparison, let's look at a few of Target's key metrics next to two of its peers:
|Target||Walmart (NYSE: WMT)||Costco (NASDAQ: COST)|
|Market Capitalization||$40.6 billion||$243 billion||$41.3 billion|
|Current P/E Ratio||14.2||15.3||24.5|
|Estimated Forward P/E Ratio||12.59||13.4||18.94|
|5-Year Historic Dividend Growth Rate||18.4%||12.69%||13.38%|
|Return on Invested Capital||9.4%||14.8%||12.4%|
Why I like it
Target makes no secret of its attempts to offer a more upscale version of competitors' stores. In addition to its continually evolving marketing efforts to stay in touch with changing marketplaces, the company works hard to align its stores' designs to better reflect how customers want to feel. As an illustration, have you ever been frustrated or experienced that nagging feeling of unease in trying to find what you seek in a Walmart store? This is one of the things Target strives to eliminate in its efforts to craft a more personal, convenient shopping experience and drive more customers through its doors. In the end, Target actively seeks customers for whom a slight margin advantage is not worth the additional stress.
Don't get me wrong; Costco and Walmart are well-oiled machines which serve their target markets with stunning efficiency, and both are great stocks in their own right. Target, however, often plays an under-appreciated second fiddle to the other retail juggernauts.
In its annual reports, Target repeatedly states it maintains an "ambitious focus on sustainable, profitable growth," with goals of increasing annual sales to $100 billion or more and growing earnings per share to at least $8 by 2017.
With nearly 1800 stores, though, how much more can Target possibly grow? Considering Walmart has around 9000 stores worldwide with over 4000 in the U.S. alone, Target has barely scratched the surface of its potential.
To that end, Target continues to expand domestically, adding 21 stores in the U.S. in 2011. The company has also seen strong results with its new compact, urban-centric CityTarget stores which are currently only open in Seattle, Los Angeles, Chicago, and San Francisco. You can bet Target will continue to roll out new CityTarget locations as it can responsibly do so.
Apart from Target's domestic operations, did you know Target has yet to expand beyond our borders? Beginning next year, however, Target plans to open 125 to 135 stores in Canada, with expectations of being able to profitably run over 200 stores in the country.
Reasons for caution
On the surface, Target appears slightly undervalued with a current P/E ratio of 14.2 as compared to the S&P 500 at 15.45, Walmart at 15.3, and Costco at 24.5. The company also has a stable 2.2% dividend which has grown quickly, along with a conservative payout ratio of 28%.
However, while TGT's dividend growth and P/E ratio is more attractive than its peers, the table above also shows its debt-to equity ratio is higher at 1.16. Though I would like to see this number come down over time, the number still represents a relatively-healthy level of debt given the company's predictable, cash-generating operations.
In addition, while Target's current ROIC of 9.4% indicates the company is creating shareholder value, we can see Walmart and Costco have achieved even more impressive returns on investment percentages of 14.8 and 12.4, respectively.
With this in mind, some of the blame for Target's comparatively-high debt levels and low ROIC can be placed on the leverage involved with running its credit card business. Thankfully, just three weeks ago, Target announced an agreement to sell its credit card portfolio to TD Bank Group (NYSE: TD) with a 7 year profit-sharing agreement. Personally, I'm elated to see Target handing over the card business to let an actual bank do the dirty work. After all, as a Textron shareholder since 2007, I'm all too familiar with the dangers of unnecessary banking exposure.
Target also plans use the proceeds from the agreement responsibly, stating in the announcement it "expects to deploy proceeds from the sale in a manner that will preserve its strong investment-grade credit ratings. Specifically, the company expects to apply approximately 90 percent of net transaction proceeds to reduce the its net debt position, with the remainder applied to share repurchase over time."
I've made no secret of my love for responsible, growing companies which are built to last a lifetime. Based on my thoughts above, I believe Target fits the bill.
In fact, I challenge you to read and absorb any of Target's quarterly filings and annual reports. In doing so, I'm confident you'll see what I see: A prudent, growing company whose returns will mop the floor with the market indexes over the long run...and let you sleep sound all the while.
Steve Symington owns shares of Textron. The Motley Fool owns shares of Costco Wholesale and Textron. Motley Fool newsletter services recommend Costco Wholesale. 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.If you have questions about this post or the Fool’s blog network, click here for information.