Before Thanksgiving hit - and the crazy bargain hunters raided the malls - we decided to pit eight dividend payers in the retail sector against each other in a single elimination tournament.
Regardless of whether you prefer to pick up last-minute stocking stuffers at Target or dirt-cheap toilet paper at Wal-Mart, don't rush to judgment on the investment-worthiness of either company. That determination can only be made after conducting a blow-by-blow fundamental analysis, not a review of our own shopping habits.
With that in mind, it's time to ring the bell and get this matchup officially underway…
~Round 1: Simple Business
Remember, we prefer simple businesses. The simpler the better, in fact, because simple businesses have fewer moving parts to get in the way and sabotage our income stream.
In this case, it's a pretty tough competition. Both Wal-Mart and Target have a relatively simple business plan - to provide almost everything a consumer might need under one roof.
That's where the simplicity ends, though.
Both companies cover products that range from home furnishings and electronics, to clothing and fresh produce.
If there's an advantage, it's slightly in favor of Wal-Mart, since the company's goal is to provide the lowest prices possible in order to move as much product (and generate as much revenue) as it can.
While Target also aims to have low prices, it's not the company's main goal. Instead, it tries to cater to both lower- and higher-income shoppers. It offers its own Target brand, and it also enters into agreements with well-known designers to produce made-for-Target clothing and accessories.
Fashion is a finicky business, which exposes Target to a bit more risk.
~Round 2: Steady Demand
Wal-Mart, with its low-price guarantee, is a bit more recession-resistant than Target. However, that doesn't make the company the clear-cut winner this round.
Remember, there's a growing income gap among U.S. consumers as we exit the Great Recession. Since Target caters to both groups, it's best positioned to capitalize on the current economic conditions, particularly during the holiday season.
~Round 3: Cash Flow Positive
As long as a company generates a ton of cash each year, it can easily afford to keep paying its dividend - and that's what matters most to us.
In the case of Wal-Mart and Target, a clear winner emerges.
Wal-Mart generated enough cash over the past year to pay almost two years' worth of dividend payments. But Target takes this round by spinning off enough cash in 2013 to make its dividend payments for over two and a half years.
~Round 4: High Cash Balance
As I'm known to say, cash is king in the financial world - and there's no exception when it comes to income investing.
We generally insist on at least enough dry powder to cover two quarters' worth of dividends. That way, even if a company stumbles for a quarter or two and doesn't generate any cash from operations, it can still afford to pay us.
Once again, both companies pass muster. But one dividend is clearly safer than the other based on its current cash balance.
Target has enough cash stockpiled to pay for over two and a half quarters' worth. However, Wal-Mart blows that out of the water, holding enough cash to pay for almost six full quarters.
~Round 5: Minimal Need for Credit
You should remember from the first matchup that, especially during a rising interest rate environment, the more debt a company carries, the less cash that's left over to pay dividends. So which list, naughty or nice, do Wal-Mart and Target fall on?
Well, the median D/E ratio for the industry is right around 0.45, and neither even comes close to that. Wal-Mart checks in with a D/E ratio of 0.71, while Target is almost triple the median at 1.1.
Although both companies have higher-than-average levels of indebtedness, neither is in immediate danger of defaulting on its loans, thanks in part to their strong cash flow generation. That said, one is less risky than the other…
~Round 6: Earnings Buffer
Earnings, similar to the high cash balances sought in Round 4, can provide investors with a buffer to protect against dividends being cut or eliminated. In order to track this cushion, one of the best metrics is calculating the dividend payout ratio (DPR) of a company. You'll recall from previous issues that I typically only recommend investing in companies with a DPR of less than 80%.
Target checks in with a trailing 12-month DPR of 43.41%, which is well within our guidelines for dividend investing. However, Wal-Mart is again the clear winner and safer investment with a DPR of 34.57%.
~Round 7: Dividend Yield and Growth
You shouldn't be surprised that a stout yield and a solid record of dividend growth top the list as two of the most important fundamentals for income investing.
Unlike the last two rounds, Target emerges the winner of the yield battle this time. It clocks in at 2.74%, compared to Wal-Mart's 2.32%.
But you'll remember that while we value strong yields, we value dividend growth much more.
Here, too, Target takes the cake. The company averaged dividend raises of 20.64% annually for the past five years, including a 19.4% hike this past May.
While Wal-Mart did boost its dividend over 18% this past year, it boasts a paltry five-year dividend growth average of 12.56%.
~Round 8: Valuation
Ask Warren Buffett or Carl Icahn or even Dan Loeb how to win every time, and they'll all say the same thing: Buy low and sell high. That's just as true for income investing as any other strategy, because it never makes sense to break the bank just to pick up a penny.
In this case, it's tough to determine a true winner.
Wal-Mart's price-to-earnings (P/E) ratio of 15.8 makes it cheaper on a historical basis to both the S&P 500 Index (17.9) and Target (16.8).
On the other hand, Target trades at the cheaper valuation, based on forward P/E ratios. It trades at 13.9 times forward earnings, compared to Wal-Mart at 15.1 and the S&P 500 at 16.5.
And the Winner Is …
After eight rounds of knockdown, drag-out competition, let's go to the scorecard…
With a score of 4 to 3, Wal-Mart squeaked by to emerge victorious in this clash of the "everything store" titans.
Thanks to its simpler business plan, larger cash reserves, minimal need for credit and a more comfortable earnings buffer, Wal-Mart was able to overcome the decrease in demand caused by a still-recovering economy to edge out Target as the winner of our second Dividend Class Warfare matchup.
On Thursday, we'll be one week closer to Christmas and also on to matchup No. 3, where we'll be pitting Burberry (BRBY.L) against Coach (COH) to see which is the best accessory retailer for income investing.
Make sure you tune in to see who comes out on top.
Safe (and high-yield) investing,
Additional disclosure: Dividends & Income Daily is a team of financial researchers. This article was written by Louis Basenese, one of our financial researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.