Company Description (Source: SEC 10-K)
Target Corporation (TGT), incorporated in Minnesota in 1902, operates in two segments: Retail and Credit Card. The Retail Segment includes merchandising operations and an online business. The Credit Card segment offers credit to qualified guests through its branded credit cards, the Target Visa and the Target Card. In addition, it offers a branded Target Debit Card.
Target is a dividend aristocrat with 44 consecutive years of increasing dividends.
Vital Statistics (Source: Google Finance)
- Recent Price: $51.93 (as of 02/16/2012)
- 52-Week Range: $45.26 - $56.00
- Market Capitalization: $25.53 Billion
- P/E Ratio: 12.13
- EPS: $4.28
A 10-year summary of sales, earnings per share (EPS), yearly high and low stock price, corresponding high and low P/E (calculated by dividing the high and low price by the EPS for the year), and average P/E (average of high and low P/E) is shown below.
Key 10-year data for Target
Sales (in Billions)
Source: MSN Money (money.msn.com)
From these data, we can plot Sales, EBIT, and EPS versus Year, as shown in the chart below.
Sales (in Billions) and EPS versus Year for Target, 2002-2011
As evident from the chart above, TGT has demonstrated reasonably predictable sales and earnings over the past 10 years, allowing us to predict EPS in the near future, say in five years (i.e. 2016), using the logarithmic regression equation for EPS = 1.308E-107 * exp(0.1232*2016) = 9.6128. This projection assumes 12 percent annual EPS growth.
A conservative average P/E estimate for the stock can be obtained as follows:
Signature P/E: A well established stock has a signature P/E, an average P/E it commands in the market based on its business. We calculate this by averaging the Average P/E over the past 10 years, excluding any outliers (data points that fall significantly beyond the other data points). The abnormally high P/E from 2002, due to temporarily depressed earnings, is an outlier, so we average the Average P/Es from the past 9 years to arrive at a signature P/E of 17.5.
High P/E estimate: A conservative high P/E estimate can be calculated by averaging the five lowest High P/Es of the 10 High P/Es from the past 10 years. Averaging the 5 lowest High P/Es from the past 10 years gives 18.
Low P/E estimate: A conservative low P/E estimate can be calculated by averaging the five lowest Low P/Es of the 10 High P/Es from the past 10 years. Averaging the 5 lowest Low P/Es from the past 10 years gives 11.7.
Average P/E estimate: This takes the average of the High P/E estimate and the Low P/E estimate, as calculated above, to give a conservative estimate of an average P/E for the stock we can expect. Averaging 18 and 11.7 gives us 14.82.
Multiplying our EPS projection for 5 years hence by the average P/E estimate gives us a projected average price for the stock: $9.6128 * 14.82 = $142.46, which represents an annual stock price return of 28.7 percent from the current price = $51.93. When we add in the 2.3 percent dividend yield, the total return expected is 31 percent a year, which means an investment in TGT today is expected to double in about 2-3 years.
Given a beta = 0.87 for TGT, a risk-free rate = 2% (using the yield on 10-year Treasury bond as a benchmark), and estimated risk premium of about 8 percent for the general stock market, we have a discount rate = 2% + 0.87*(8%) = 8.96%. Applying this discount rate of 8.96%, our projected price of $142.46 in 5 years translates to a target price = $92.76 in today's dollars. This is about 79% upside from the current price of $51.93, suggesting the stock is undervalued right now. For a good margin of safety, investors are well advised to buy only if the current price is at least 20% below the target price. The current price is 44 percent below the target price, offering plenty of margin for error.
Current P/E Compared with Signature P/E
The stock's current P/E should be compared with its signature P/E, since established stocks tend to revert back to their respective signature P/Es over the long term. The current EPS = 4.28, giving us a current P/E = 12.13. This is about 69% of the stock's signature P/E of 17.5, suggesting the stock is undervalued right now. To provide some margin for error, we should look to buy when the current P/E is 80% or less of the stock's signature P/E, so the current valuation of TGT appears attractive on a historical basis.
Target's P/E Compared with Competitors' P/Es
It is helpful also to compare Target's valuations with those of its competitors and peers in the discount variety stores industry. Wal-Mart and Costco are Target's main competitors, but Target also competes with discount dollar stores like Family Dollar (FDO), Dollar General (DG), and Dollar Tree (DLTR) domestically. Current P/E and Forward P/E are tabulated below for the company and its competitors.
Wal-Mart Stores (WMT)
Costco Wholesale (COST)
Source: MSN Money (money.msn.com)
Target trades at a discount compared to all its competitors. The stock appears attractively positioned for investors to capitalize on its low market pricing, as compared to its peers.
Historically, for the past 10 years, Target has underperformed most of its competitors, except for Wal-Mart, and the S&P 500 (of which Target is a part). This underperformance occurred during a period of strong, consistent earnings growth averaging 12 percent a year. The most likely reason is that investors' expectations for Target were too optimistic 10 years ago, with P/E in the high 20s. Now that investors' expectations have adjusted lower, Target is more likely to outperform looking forward.
Lastly, we calculate the Risk Index, calculated as (Current Price - Forecast Low Price)/ (Potential High Price - Forecast Low Price) to give an estimate of the risk: reward ratio. Risk index less than 20% is desired, which gives us +200% potential returns for every risk of 50% loss we assume.
The Forecast Low Price is calculated by multiplying the Low P/E estimate by the Forecast Low EPS, to give a conservative estimate of low price for the stock in 5 years, assuming zero EPS growth and low valuation. Forecast Low EPS is estimated by averaging the EPS over the past 5 years. For growth stocks with predictable earnings growth, EPS in 5 years should not be any lower than this conservative estimate. For TGT, the forecast low EPS is equal to 3.344, so the Forecast Low Price = 11.7 * 3.344 = $39.03.
The Potential High Price is calculated by multiplying the High P/E estimate by the projected EPS in 5 years, giving us a price target in 5 years should the stock command a high P/E. For TGT, this equals 18 * 9.6128 = $172.73.
Thus, the Risk Index = ($51.93 - $39.03) / ($172.73 - $39.03) = 10%. Since this is below 20%, the stock has a favorable reward to risk ratio at the current price.
Target Corporation, currently selling around $51.93, has a target price = $93. The stock is currently trading at a discount not only to its historic P/E, but also to its peers, and has a favorable risk index. Therefore, I rate the stock a BUY at the current price.
Disclosure: Use this information as a starting point for your own due diligence, before buying any stock. If you do buy, be sure to read any annual reports (10-K) and quarterly reports (10-Q) to ensure that the fundamentals remain good and the stock is on target to reach its projected price. After holding for five years, repeat the analysis detailed in the article to decide whether to continue to hold, add, or reduce your position. I am long WMT.